PMI is one of the most powerful economic indicators that are useful to investors. Its signals give an idea of the further GDP movement, and, accordingly, draw conclusions about the dynamics of exchange rates and the stock market.
Purchasing Managers Index – a finger on the economy pulse
The index of business activity in the manufacturing sector (also known as the Purchasing Managers Index, abbreviated PMI) is one of the oldest tools for assessing the economy. It began to be calculated at the request of U.S. President Herbert Hoover in 1931. Hoover sought to pull the country’s economy out of the collapse of the Great Depression, but he suffered from a lack of reliable information about what was happening at the enterprises, on the “ground”.
The National Association of Purchasing Managers (now ISM, The Institute for Supply Management) began to collect information, interviewing suppliers of industrial enterprises. The idea turned out to be productive. After all, supply managers are simply obliged to keep abreast of production activity: they must provide production with everything necessary as soon as the volume of external orders increases and, conversely, reduce purchases if the number of new orders decreases.
ISM PMI has been calculated monthly since 1931 (the break was only for four years during World War II). In the 1990s, this indicator began to be actively used by other countries. Together with ISM, the second reputable PMI provider is the Markit Group. PMI is calculated in many countries of the world (sometimes by several organizations at the same time).
Although Americans continue to focus on manufacturing PMI, over time, index calculations for non-industrial sectors and a final indicator calculated from these two sub-indices have been added to it. Sometimes the PMI of individual industries, such as construction, can be useful. Since usually industrial versions of the index are published on the first day of the next month, this allows you to quickly assess the prospects of the economy not only in the largest countries of the world, but also in the global economy as a whole.
What is PMI talking about?
The value of the general index of 50 and higher indicates economic growth, while smaller ones indicate a decrease. However, this is not a signal of a recession, but only a signal of danger. A recession occurs when the index for several consecutive months shows values between 40 and 45 points.
Not only the general index may be interesting, but also its components and the results of the answer to additional questions. Investors in the bond market can, for example, separately note the increase in purchase prices – it indicates the acceleration of industrial and consumer inflation. Inflation is the enemy of bondholders, as it eats up some of the income from their investments.
How is PMI calculated?
Let’s consider classic manufacturing PMI. ISM interviews managers of 300 industrial companies in several areas:
- new orders from consumers;
- volumes of finished products;
- hiring new employees;
- speed of delivery of orders by suppliers (lateness);
- stock levels.
These five questions are used to calculate the index. Five more are added to them – to create an overall picture, the answers to them are analysed in the report:
- customer inventory level (assumptions made from communicating with suppliers);
- dynamics of purchase prices;
- volume of outstanding orders;
- dynamics of new export orders;
- import situation.
Managers do not have to give specific numbers. The “diffuse” index, that is, does not evaluate the absolute level, but the dynamics in the last month: for each question, the manager only needs to indicate the direction in which the situation has changed (growth, decrease or without change).
Suppose 40 managers out of 258 responded that the situation with new orders has improved, 170 indicated “no change” and 48 reported a decrease in the volume of new orders. Researchers consider the number of “positive” answers as a real share of the total number of answers, the share of “no change” answers are divided by 2, and the deterioration is generally ignored. Let’s total up new orders: 40/258 + (170/258) / 2 = 15.5 + 32.9 = 48.4.
The general index is calculated as a weighted average, where new orders have the maximum weight (30%), inventory levels have minimum (10%).