The already slow recovery slowed further in March for the service sector. Although the industry continued to expand last month, it did so at a more modest pace than in January and February, according to the Institute for Supply Management. Its Non-Manufacturing Index fell to 57.3 from 59.7 in February. A score above 50 indicates expansion, but the decline means that growth has slowed. Why isn't the sector recovering more rapidly?

March was the first month since August 2010 when the NMI declined. Its value for the month puts it back near its December level. That's a pretty significant reversal in the 6-month trend. Here's the chart from ISM showing the index components, along with a comparison for last month's performance:

ism services 2011-03.png

As you can see, most components were growing last month, which is a good sign. But the rate of change shifted from growing faster in February to growing slower in March for many of the components. A few factors drove the change, but weakening sentiment appears to be one of the leading causes.

If you compare new orders, supplier deliveries, the backlog of orders, and new export orders for March and February, you will notice that they didn't worsen very much. The indices for new orders and supplier deliveries both declined slightly, but those for the backlog of orders and new export orders both increased month-over-month. Moreover, the index for inventories was also flat. All of these indicators together imply that the sector didn't actually perform much worse in March than in February.

But if you look at the more forward looking components of the index, then you see sentiment may be declining. For example, despite the index for inventories growing at the same rate in March as February, inventory sentiment worsened significantly. In other words, suddenly in March, companies were relatively less content with the same inventory growth they experienced in February. Additionally, hiring appears to have slowed, since the index for employment growth declined. That's despite demand appearing to have grown at nearly the same rate in March as February.

The bad news here is pretty obvious: the service sector appears to be pessimistic about the future. When the economy is in recovery mode, you would hope to see the opposite. Hiring won't be brisk if firms have little confidence that revenues will increase in the future.

But a silver lining is that little tangible evidence indicates that the sector's growth is slowing due to actual business activity declining. Although the index for this component took a hit in March, the other indices don't really support the big drop in the business activity index. As a result, it's a little unclear if business activity's growth really slowed, or if firms merely perceived that the recovery is slowing.

If sentiment is driving the change, then it can quickly shift if the factors that have firms worried -- presumably fears of weakening consumer demand, commodity price increases, and global instability -- turn out to be temporary shocks. Of course, if they persist, then that perception becomes reality and the recovery will slow.

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