At the beginning of every month, economists and business leaders await the publication of the Purchasing Managers Index (PMI) by the Institute for Supply Management (ISM). This index is considered a key indicator of the health of the economy and a harbinger of its future performance. What is this index, how is it compiled and why is it important? Let’s look at this important index.
The ISM is a non-profit professional organization with 40,000 members engaged in supply management and purchasing. The first day of each month the ISM announces the results of its survey of 400 purchasing managers chosen for diversity by geography and industry. There are five parameters in the index. Each parameter has an individual weighting. These parameters are:
· Production level (weighting of 0.25)
· Employment level (0.20)
· New orders received from customers (0.30)
· Inventories (0.10)
· Supplier deliveries (faster or slower than usual) (0.15)
Each purchasing manager can give one of three possible responses to the survey questions: They can respond with “better”, “worse” or “same”. The answer is based on the change in the parameter from the previous month. Each manager would respond to the survey question based on what he sees in his company or industry in the past month. The result is factored by the weighting of the particular question. The resulting compilation for the PMI can range from 0 to 100. The PMI is a “diffusion index”. It measures the percentage of respondents that reported “better” conditions from the previous month against the percentage reporting “worse”. As an example, if the PMI index was 50, this meant an equal number of purchasing managers reported “better” and the same number reported “worse” for a the month. If the index is greater than 50, it indicates expansion in the economy. If the index is less than 50, it indicates contraction in the economy.
The PMI is both a measure of actual conditions and a critical sentiment measurement. Although manufacturing is a small percentage of the total Gross Domestic Product (the overall measure of the size of the economy) if manufacturing is expanding, the total economy should be expanding. For this reason, the PMI is considered by economists as a good indicator of future GDP levels.
It must be recognized that the PMI has a strong element of subjectivity. However, its consistency makes the PMI a leading indicator for the Federal Reserve and is usually mentioned in the Federal Open Market Committee (FOMC) minutes after each meeting.
The advantages of the PMI are that:
1. It is a good predictor of other data such as the GDP and Bureau of Labor Statistics manufacturing reports.
2. The anecdotal remarks that accompany the report can give a more complete view of the economic conditions.
3. It shows changes from the previous month’s report and can show trends.
There are some weaknesses in the report that should be noted:
1. It only shows activities in the manufacturing sector. However, the ISM also publishes a PMI Non-Manufacturing Report that covers service sectors.
2. This is a subjective report. The monthly results are only important relative to the previous months.
In your reading of the PMI report at the beginning of each month, you can ask yourself these same five questions. Compare your answers and your company’s performance to the national ISM survey.
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