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Interpreting manufacturing survey factors

Mex IPM factorsEnlarge Graph

Manufacturing surveys, such as the ISM Index in the U.S. or the IPM Index in Mexico, are used worldwide to measure in a frequent manner the current and expected activity in the sector. While the list of questions sent out may include several items, the manufacturing index itself is generally composed of five main drivers: new orders, production, employment, supplier delivery times, and inventory levels.

For each factor, the respondents must choose if the factor has increased, stayed the same, or decreased, and the answers are assigned scores of 0, 50 or 100, respectively. The overall index is calculated based on a weighted average of these replies, with values above 50 implying expansion and values below 50 implying contraction.

The graph above shows the Mexican IPM index change per factor from November to December 2012. Note that in this case, supplier delivery times and inventories would clearly have the biggest effect on a simple average of the factors, but other adjustments come into play before formulating the final index. The main one is the weighting of the factors, to give more importance to factors further up the logistics chain and therefore providing a higher impact on production. The list below shows the factors in their respective order in the logistics chain. The weighting assigned are as follows:

  • New orders, 30%
  • Production, 25%
  • Employment, 20%
  • Supplier delivery times, 15%
  • Inventory levels, 10%

Additionally, answers are also weighted by the relative size of the companies answering the surveys, so that larger companies have a higher impact, commensurate with their contribution to the sector. The final key adjustment is the historical seasonal adjustment to allow for direct comparison with previous periods.  The factors adjusted vary by country1.

For all the reasons mentioned above, simply glancing at the index factors will not explain completely why the overall index moved as it did; deeper analysis is required to understand the contribution of each factor. Looking at each factor separately is a qualitative analysis, and the value is the insight given by the direction and relative movement of each factor to try to predict the outlook for the next period, rather than quantifying exactly how much each factor contributed.

In the case of Mexico, a possible interpretation of the data above is that manufacturing is picking up, but in the short term the effect will not be as evident since producers will first use up their excess inventory, hence the faster delivery times shown2.

This survey is a key data point for investors in the iShares MSCI Mexico Index Fund (EWW) or the locally traded iShares NAFTRAC (MEX:NAFTRAC). It may also impact an overall trend for investors looking at Latin America as a whole through iShares S&P Latin America Fund (ILF) and SPDR S&P Emerging Latin America ETF (GML), all of which have approximately 25% exposure to Mexico. The HSBC manufacturing surveys cover several emerging markets that are also tracked by respective ETFs.

  1. The ISM Index does not seasonally adjust inventories since they do not meet the criteria for seasonal adjustments (e.g. lack of statistical significance). The Mexican IPM does not adjust both inventory and supplier delivery times for the same reason.
  2. For delivery times, a lower index value means faster deliveries, which are associated with reduced orders from producers, a negative signal.