Manufacturing contracts to weakest in three years

Manufacturing unexpectedly contracted in November, falling to its lowest level in over three years in a sign the sector may be struggling to gain traction, according to an industry report released on Monday.

The Institute for Supply Management (ISM) said its index of national factory activity fell to 49.5 in November from 51.7 the month before. The reading was shy of expectations of 51.3, according to a Reuters poll of economists. The 50 level in the index is the line between expansion and contraction.

The figure was the softest since July 2009 when the U.S. economy was struggling in the aftermath of the financial crisis, and may have been aggravated by the superstorm Sandy that hit the U.S. east coast in late October.

The return to contraction was a surprise after the sector grew for two straight months and marks a reappearance of the economic weakness seen over the summer months that investors and economists had hoped was behind them.

"There are two ways of looking at this," said Christopher Low, chief economist at FTN Financial in New York.

"We had two months of growth and now we are back to contraction, that is one way. The other, which is a little more realistic is that since May the index has been very close to 50 and I think what we are seeing is that manufacturing has stalled and has yet to recover."

U.S. stocks lost ground after gaining earlier on Chinese reports that showed manufacturing in the world's second-largest economy picked up pace during the month.

The S&P 500 rose 0.25 percent and the Dow industrials briefly turned negative.

The new worries over the economy come as investors are on guard over negotiations in Washington aimed at averting the so-called "fiscal cliff", a series of tax hikes and spending cuts that economists say could push the economy into a recession.

The ISM survey was at odds with a separate manufacturing survey also released on Monday. Financial information firm Markit said rising demand from domestic and foreign customers helped U.S. manufacturing grow in November at its quickest pace in six months, though hiring remained sluggish.

ISM's survey, which focuses more on large companies, also seemed to contradict a survey of smaller firms published on Monday, though this was conducted a month earlier.

The Thomson Reuters/PayNet Small Business Lending Index showed borrowing by small U.S. businesses rose in October, as the central bank launched its latest round of monetary stimulus to encourage borrowing and spending.

U.S. construction spending, also during October, was a bright spot however as the housing sector recovery appears to be gaining traction. Spending rose by the most in five months, with stronger spending on homes outpacing tepid gains in business and government projects.

Monday's reports mark the start of a relatively busy week for economic data releases that comes to a head on Friday with the closely watched monthly payrolls report for November. Economists in a Reuters poll expect 93,000 jobs were created during the month, down from 171,000 the month before.

(Reporting By Edward Krudy; Editing by Chizu Nomiyama)