Why do key purchasing managers’ index readings move markets?
What is the purchasing managers’ index (or PMI)?
In general, the Purchasing Managers Index (or PMI) is a composite measure of economic activity. The PMI is based on surveys of a cross-section of private sector companies, which may be selected based on objective economic criteria, such as revenue contribution to industry sales, industry contribution to gross domestic product (or GDP), et cetera.
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Headline PMI readings are usually issued for the manufacturing and services sectors. In turn, these indices are composed of a number of diffusion indices that give a measure of a particular economic activity—like employment, new orders, deliveries, et cetera. Index readings are expressed on a scale of 0 to 100, with a reading above 50 implying that business activity has expanded month-on-month, while a reading below 50 implies contraction. A reading of 50 is a neutral reading and would mean business activity has neither expanded nor contracted.
In this series, we’ll focus on the manufacturing PMI issued by three major institutions, measuring manufacturing activity in the U.S.
- The oldest supply management institution in the world, the Institute for Supply Management, issues the Manufacturing ISM Report on Business, which contains monthly PMI readings for the manufacturing sector in the U.S.
- ISM-Chicago, an affiliate of the Institute for Supply Management mentioned above, issues its monthly Chicago Business Barometer, or Chicago PMI, based on a survey panel of purchasing or supply-chain professionals, primarily drawn from membership of the ISM-Chicago. Panelists may include professionals from both manufacturing and non-manufacturing companies.
- Another major economic data provider, Markit Intelligence, issues monthly PMI readings based on economic surveys of selected companies across key sectors.
All three indices have differences in data sources and compilation methodologies. For a detailed description of the differences, read Part 9 of this series.
Why are PMI readings important economic indicators?
PMI readings are important indicators, as they provide information about economic headwinds. While manufacturing activity is a coincident indicator, PMI components, manufacturing jobs, and new and pending orders are leading indicators. These inform decision-makers as to whether manufacturing activity is on the rise.
PMI readings also indicate performance trends for companies in the manufacturing and industrial sectors. The Vanguard Industrials ETF (VIS) invests in these sectors. VIS tracks the MSCI US Investable Market Industrials 25/50 Index. The Index consists of the stocks of large, medium, and small U.S. companies in the industrials sector in the aerospace and defense, construction, and logistics sectors—among others. The top ten holdings in VIS include S&P 500 Index (VOO) components, Danaher Corp (DHR), and United Technologies Corp. (UTX). An increase in production and new orders in the manufacturing sector would significantly benefit these companies, as they act as suppliers to the manufacturing sector.
An increase in production activity will also imply that economic growth is gaining traction and the low rate environment may not persist. Bond prices move inversely to interest rates. One way of profiting from rising rates is to invest in inverse bond funds like the ProShares Short 20+ Year Treasury Fund (TBF) and the Barclays iPath US Treasury 10-Year Bear ETN (DTYS). Inverse bond ETFs provide the inverse return of the underlying benchmark index.
To read about the Institute for Supply Management’s Report on Business for March, featuring PMI readings, read on to Part 2 of this series.