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PMI Index: An Overview on Reading it


Release Date: 1st business day of month
(For monthly PMI Index reports)

The Purchasing Managers Index contains the most visible data contained in the monthly report entitled the ISM Report on Business. This report is published by the Institute for Supply Management, a kind of trade group for supply chain and purchasing professionals. Ordinarily, when one hears the words “PMI Index,” this refers to the “PMI Manufacturing Index.”

A “PMI Services Index” also comes out a few days later in the month. While the Manufacturing segment only constitutes about 20% of today’s U.S. GDP, this manufacturing data serves as an alternative way to monitor GDP, as well as a leading indicator of upcoming turns in GDP trends. Included in the Report on Business is a variety of brief anecdotal observations like, “Avian flu is having a huge effect on egg pricing,” and “[Furniture] business remains strong, with housing starts being up.” Despite a proliferation of numbers here, this report is mostly subjective, almost to the extent of the Beige Book.

To generate this index, the ISM issues a monthly survey to a large, diversified, selection of about 450 purchasing managers. These managers are asked whether business has 1) improved, 2) declined, or 3) remained the same in the following ten areas: New Orders, Production, Employment, Supplier Deliveries, Inventories, Customers’ Inventories, Prices, Backlog of Orders, Exports, and Imports. Utilizing this data alone for the index and the sub-indexes, the PMI will measure above 50 if business is expanding, below 50 if it is contracting and 50 if it has remained the same.

Let’s look at the PMI report from July 1, 2015. Here are the headline numbers:

Previous

Consensus

Consensus Range

Actual

54

53.7

53.4 to 55

53.6


This 53.6 headline reading matches January’s for the highest of the year. The new orders and employment indexes rose robustly. Most of the indexes described and projected growth. An exception is the Production Index which fell from 54.5 to 54. Still, we can add the PMI to the list of recent economic reports that appear to contradict the final Q1 GDP reading of -0.2%.

For many, though, the PMI is most noteworthy in its role as a leading and, to a lesser extent, coincident indicator for the economy and for upcoming GDP numbers. Overlaid charts of the PMI monthly indexes and year-over-year percentage change in GDP show that for a number of years now PMI readings have very frequently led these GDP figures at turning points. For instance, recently the January, 2015 PMI was widely interpreted to have foretold the Q1 2015 -0.5% drop in GDP. And the February, 2014 PMI number was seen to have foreshadowed Q1 2014 downturn in GDP. Moreover, GDP numbers come out only quarterly, while PMI numbers arrive monthly. Often this means that analysts utilizing the PMI have an incrementally even bigger jump on turns in the business cycle. Occasionally, however, these turns in PMI readings occur coincidently or simultaneously with turns in GDP trends. PMI numbers are of course much less useful in these cases. Many commentators have noticed that readings predicting recessions, often pegged at measures of 42 or under in the PMI, are a little less accurate in recent years in large part at least because the manufacturing sector represents only about 20% of modern GDP.

Many have also noticed similar trends between the Manufacturing Employment Index and the BLS labor numbers. Turns in this index often precede turns in BLS labor trends by a few weeks to a few months. Recent history has shown that this employment index does a better job of predicting downturns in hiring than upturns. This is largely because substantial upturns in manufacturing hiring have been few and far between in the last few decades.

One can successfully trade the S & P Index using only PMI numbers, claims Arthur Field, former hedge fund manager for Fidelity International. He suggests that one should buy the S & P when the PMI “bottoms on a monthly basis.” He says that historically over a forty year period 11 of 16 trades were profitable for a hypothetical gain of $507,055.00

Markit Ltd. also publishes many PMI readings for many countries overseas. As trends in business cycles and employment are to a great extent global, many analyses like those mentioned above work with these PMI Indexes and can even help to forecast trends here in the states.

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