Editor’s Note: Bridget Strand, Ph.D., joined Modern Distribution Management and its sister company Industrial Market Information as Economist in late 2013. Read more about Strand at the bottom of this blog.
The Institute for Supply Management (ISM) released the March 2014 manufacturing Purchasing Managers’ Index (PMI) this past Tuesday. While this indicator is closely followed by companies and the overall market it is also not widely understood in terms of its economic importance and the composition of the index itself.
While “official” economic data is often preferred by economists, researchers and financial analysts, the release of the ISM data precedes official data from the government, and it captures the sentiment of the people on the ground. This survey targets those in the manufacturing sector that make the decisions related to inventory management; it includes information on their orders, employment, production and supplier-distributor deliveries.
The index is often interpreted as a major indicator of the health of the U.S. manufacturing sector, but the underlying components are not always taken into account for the signals they contribute, helping to characterize the economic situation in a more holistic manner.
Business owners in the manufacturing and wholesale trade sectors should use the index to confirm what they are observing in the market; managers should incorporate the data into forecasts and even business plans if applicable.
The components of the PMI are equally weighted at 20 percent each: New Orders, Production, Employment, Supplier Deliveries and Inventories. All but Inventories are seasonally adjusted. In addition, the ISM publishes monthly indices on Customers' Inventories, Prices, Backlog of Orders, New Export Orders and Imports, which are also not seasonally adjusted but are watched by various market and industry groups.
The PMI is a diffusion index, which captures the change in data or sentiment rather than the absolute value. In this case, each survey response provides a “Better,” “Same” or “Worse” response for each of the sub-indices. This is another reason that the PMI is carefully watched by the market as changes in data/sentiment are often more important indicators than absolutes.
A PMI over 50 percent represents growth or expansion within the manufacturing sector of the economy compared with the prior month. A reading under 50 represents contraction, and a reading at 50 indicates an equal balance between manufacturers’ reporting advances and declines in their business.
For the March 2014 data, released on April 1, the overall index increased from 53.2 percent of respondents saying “better” to 53.7 percent. This is interpreted as an indication of expansion in the manufacturing sector for the tenth consecutive month. Of the sub-indices, Production had a 7.7 percentage point increase indicating substantial optimism in productivity and output. New Orders also increased while Employment was slightly down yet still over the 50 percent level that indicates expansion.
In the March report, there was a lot of positive sentiment around business conditions and overall economic health while there were continued concerns over weather-related supply chain and final goods delivery issues. Of 18 industries covered in the report, 14 reported growth in March. Four reported contraction. This industry-specific data is less important on a monthly basis, but is important to observe over time as it can indicate industry trends.
The importance of the ISM index goes a bit further as the Production index is used to help predict industrial production (as part of the Industrial Production and Capacity indices provided by the government). The prices index is used to help predict the closely watched producer price index (PPI) and the New Orders index is used to help forecast factory orders volume.
Lastly, the Employment index is a major indication of manufacturing employment and The Conference Board uses the Supplier Deliveries index as an input into their Leading Economic Indicators index, which is used at every level of government to track the state of the national economy.
The true value of the ISM report is its timeliness. It reflects important price and employment data that is released in advance of official government data and provides inflation and labor market insight that is valuable to investors and business owners alike. Data on orders, inventory and production speak to the health of the manufacturing sector and are a testament to U.S. economic strength.
Bridget Strand, Ph.D., is MDM and Industrial Market Information’s economist. Strand has a background in applied economic theory and international trade and development. Prior to joining MDM and IMI, Strand worked as an economist for the City and County of Denver, CO, as well as in roles in the finance sector and as a consultant with the OECD in Paris and the World Bank. Strand received a Bachelor’s Degree in Economics and Politics from New York University and her Ph.D. from the University of Colorado at Boulder with a concentration in International Trade and Investment, as well as Development Economics. She has research published in a number of journals.
To reach Bridget Strand, email [email protected]