The growth manifested in January has been interrupted. However, the drop in activity in February was not enough to plunge the Credit Managers' Index (CMI) back into negative territory. In fact, a marginal gain moved the combined index from 55.1 to 55.2 and was somewhat anticipated due to the inspiring recent expansion in the manufacturing sector. Still, it feels more like a decline when compared to the big gains made in January.

"Starting in the latter part of 2009, manufacturing sector businesses began rebuilding inventories back to respectable levels; a process the CMI predicted," said Chris Kuehl, Ph.D., economist for the National Association of Credit Management, which issues the CMI report each month. During the depths of this recession, most businesses did everything possible to reduce costs and protect cash flow. For several months, the CMI illustrated this point with reports of worsening unfavorable factors: more disputes, rejections of credit applications and dollars beyond terms. By the end of 2009, the CMI began to show a shift-businesses that owed money started the process of paying down debt in anticipation of needing access to credit in the near future. This shift in attitude has historically shown that expansion begins within a month or two, which is what started to transpire in December 2009 and January of this year.

"The development in manufacturing was matched to a lesser extent by similar movement in the service sector, and other economic indicators added to the notion that something was stirring in the economy," said Kuehl. Fourth quarter GDP numbers for 2009 were up 5.9%, and the Purchasing Managers Index climbed to the mid-50s with new orders all the way up to the mid-60s. "There now appears to be a reversal under way, but it may be more accurate to refer to this as a breather," Kuehl said.

"The first phase in an economic recovery is the replenishment of reduced inventory and there can't be growth without the supply to meet expected demand," said Kuehl. "If there had been no effort to bolster inventory levels, the arrival of demand would have provoked massive shortages, bottlenecks and ultimately inflation. For now, businesses are looking at low interest rates, commodity prices and labor costs. This is the safest time to build that base, but now they have to wait for the second phase-consumer confidence, which remains in the doldrums to an extent."

Conference Board reports show a big drop in consumer confidence because of concerns about the employment situation. At the same time, there are reports coming in from big retailers such as Lowe's and The Home Depot suggesting that consumers are shopping again. The consumer has yet to commit and until that happens, the economy remains in a waiting position.

The CMI shows that sales were flat in February after a major jump in January, but slight increases in new credit applications and the amount of credit extended indicate that credit remains somewhat accessible. Among the negative factors, the biggest changes took place in disputes and bankruptcies. Neither was unexpected: more companies are struggling with debt and will be maneuvering for more time, and the end of a recession is often harder on companies than the recession itself as they start to see pressure from competitors and may not have the ability to respond.

Manufacturing Sector

The most dramatic change in February was in the manufacturing sector where there was a gain in inventory. Decisions to boost inventory happened toward the end of 2009 and while the resulting buildup has taken about three months, there is evidence of slowdown as the suppliers wait for demand. Most of the favorable factors remained pretty solid in February with an increase in sales and a pretty substantial surge in new credit applications. "Unfortunately, dollar collections were down, likely reflecting the fact that many manufacturers are now stretching to get in position for the expected recovery and that has affected their ability to pay," said Kuehl.

The big shifts in the sector took place in the non-favorable items. There were more disputes, dollars beyond terms and bankruptcies. There seem to be different factors at work with each. The bankruptcy situation tends to worsen at this stage in a recovery. "During the depths of a recession, the pressure on business is entirely from the economy itself and almost everybody is in the same situation-just hunkering down to survive and waiting for the economy to rebound," said Kuehl. "Once the economy starts to move, competition within industries becomes a factor-especially for those businesses better prepared for the downturn. Just enough pressure is applied on the weaker competitor that it becomes too much and they are forced to capitulate."

The disputes and the dollars beyond terms seem to stem from some companies getting over-stretched again. They are trying to get in shape to meet expected demand and competitive threats to their market share, but are still struggling with cash flow. Acknowledged tightness in the lending sector is also reducing the options these companies have that would enable them to float further until the demand hits.

The slowdown experienced in manufacturing in February may extend into March unless demand starts to materialize, which appears to be a 50-50 proposition at best at this point.

Service Sector

There was a drop in the service sector this month from 55.0 to 54.8 and January was more anemic than for manufacturing. The service sector is now feeling the effects of a greater number of layoffs. The manufacturing sector, led by construction, has already taken its lumps. There were portions of the service sector that also got hit early-most notably financial services-but retail rebounded in the holiday season.

The biggest drops occurred in sales and new credit applications. "Some of this is expected as consumer spending is generally slow this time of year. This is being exacerbated by more caution in consumer confidence than in past years as reflected in Conference Board data," said Kuehl. "But business expansion in retailers like The Home Depot, Lowe's, Target and Walmart somewhat contradicts these findings."

There were some declines in the unfavorable factors as well, but better news was sprinkled in. The number of accounts placed for collection increased, but filings for bankruptcy improved to the best number seen in over two years. "The good news here is that there are normally a lot of retailers facing bankruptcy after the holiday season. If they were limping into the end of 2009 needing a truly dazzling year to survive, they probably did not get it," said Kuehl. "It seems the purge in retail took place last year and most of the sector has survived to fight for a place in the 2010 sweepstakes."

February 2010 vs. February 2009

The dramatic improvement from year to year is still pretty obvious. February of last year was clearly a period in the middle of the recession, but as the chart shows, this is when conditions started to improve. From this point forward, the gap will narrow. "The index was still well below the 50 mark until September 2009, but that means that within five months, all reflected chart numbers will be above above 50 unless there is an unexpected crash on the horizon," said Kuehl.