Economic Indicators: Purchasing Managers Index (PMI)

Economic Indicators: Purchasing Managers Index (PMI): "Economic Indicators: Purchasing Managers Index (PMI)

By Ryan Barnes

Release Date:	The first business day of the month
Release Time:	10am Eastern Standard Time
Coverage:	Previous month's data
Released By:	Institute for Supply Management (ISM)
Latest Release:	http://www.ism.ws/ISMReport/

Background
The Institute for Supply Management (ISM) has is responsible for maintaining the Purchasing Managers Index (PMI), which is the headline indicator in the monthly ISM Report on Business.The ISM is a non-profit group boasting more than 40,000 members engaged in the supply management and purchasing professions.

The PMI is a composite index of five "sub-indicators", which are extracted through surveys to more than 400 purchasing managers from around the country, chosen for their geographic and industry diversification benefits. The five sub-indexes are given a weighting, as follows:

• Production level (.25)
• New orders (from customers) (.30)
• Supplier deliveries - (are they coming faster or slower?) (.15)
• Inventories (.10)
• Employment level (.20)

A diffusion process is done to the survey answers, which come in only three options; managers can either respond with "better", "same", or "worse" to the questions about the industry as they see it. The resulting PMI figure (which can be from 0 to 100) is calculated by taking the percentage of respondents that reported better conditions than the previous month and adding to that total half of the percentage of respondents that reported no change in conditions. For example, a PMI reading of 50 would indicate an equal number of respondents reporting "better conditions" and "worse conditions".

What it Means for Investors
PMI is a very important sentiment reading, not only for manufacturing, but also the economy as a whole. Although U.S. manufacturing is not the huge component of total gross domestic product (GDP) that it once was, this industry is still where recessions tend to begin and end. For this reason, the PMI is very closely watched, setting the tone for the upcoming month and other indicator releases.

The magic number for the PMI is 50. A reading of 50 or higher generally indicates that the industry is expanding. If manufacturing is expanding, the general economy should be doing likewise. As such, it is considered a good indicator of future GDP levels. Many economists will adjust their GDP estimates after reading the PMI report. Another useful figure to remember is 42. An index level higher than 42%, over time, is considered the benchmark for economic (GDP) expansion. The different levels between 42 and 50 speak to the strength of that expansion. If the number falls below 42%, recession could be just around the corner. (To learn more, read Recession: What Does It Mean To Investors?)

As with many other indicators, the rate of change from month to month is vital. A reading of 51 (expanding manufacturing industry) coming after a month with a reading of 56 would not be seen favorably by the markets, especially if the economy had been showing solid growth previously.

The PMI can be considered a hybrid indicator in that is has actual data elements but also a confidence element, like the Consumer Confidence Index. Answers are subjective, and may not always relate to events as much as perceptions. Both can have value to investors looking to get a sense of actual experiences as well as see the PMI index level itself.

Bond markets may look more intently at the growth in supplier deliveries and prices paid areas of the report, as these have been historical pivot points for inflationary concerns. Bond markets will usually move in advance of an anticipated interest rate move, sending yields lower if rate cuts are expected and vice versa. (For more insight, see Get Acquainted With Bond Price/Yield Duo.)

PMI is considered a leading indicator in the eyes of the Fed, as evidenced by its mention in the FOMC minutes that are publicly released after its closed-door meetings. The supplier deliveries component itself is an official variable in calculating the Conference Board's U.S. Leading Index.

There are regional purchasing manager reports, some of which come out earlier than the PMI for a given month, but the PMI is the only national indicator.

Strengths:

• Very timely, coming out on the first day of the month following the survey month
• A good predictor of future releases, such as GDP and the Bureau of Labor Statistics (BLS) manufacturing reports
• Anecdotal remarks within the release can provide a more complete perspective from actual professionals (like in the Beige Book).
• Report displays point changes from the previous report, along with the length in months of any long-term trends shown for the "sub-indicators", such as inventories or prices.
• Commodities, such as silver, steel and copper are reported individually regarding the supply tightness and price levels noted in the previous month.

Weaknesses:

• Only covers manufacturing sector - the PMI Non-Manufacturing Business Report covers many other industries in the same manner
• Survey is very subjective in its data retrieval compared to other indicators.
• Regional reports released earlier (Philly Fed, Chicago NAPM) may have high correlations and can take some of the steam out of this release.

The Closing Line
The PMI is a uniquely constructed, timely indicator with a lot of value on Wall Street.

It is most useful when taken in context with more data-driven indicators, such as the Producer Price Index and GDP, or in conjunction with the ISM Report Non-Manufacturing Report on Business."