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Why this week’s releases are critical for your ETF investments

Part 4
Why this week’s releases are critical for your ETF investments (Part 4 of 8)

Why the Fed will keenly watch the purchasing managers releases

Purchasing managers’ indexes

The Institute of Supply Management (or ISM) will release its purchasing managers’ index (or PMI) for April on Thursday, May 1. Markit Intelligence, a major economic data provider, will also release its PMI manufacturing reading for April on the same day. While manufacturing reports overall in March have been positive, the PMI reports for April will indicate whether this resurgence is due to the bounce-back after January and February’s weather-induced manufacturing slump or a broader trend.

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What is PMI?

In general, PMI is a composite measure of economic activity. 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 or industry contribution to gross domestic product (or GDP).

Headline PMI readings are usually issued for the manufacturing and service 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, or deliveries. 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.

Highlights from the March PMI reports issued by the ISM and Markit Intelligence

  • Both the ISM and Markit manufacturing PMI releases reported an increase in manufacturing activity.
  • The ISM’s PMI increased by 0.5% to 53.7%, its tenth consecutive monthly increase. This indicates an increase in the pace of manufacturing activity.
  • Fourteen out of the 18 industry groups covered by the ISM PMI registered expansion in March, the top three being petroleum and coal products, transportation equipment, and furniture and related products.
  • The Markit PMI decreased by 1.6 to 55.5, indicating growth in manufacturing activity at a decreasing pace.
  • Although the Markit PMI declined, new orders and output were healthy, with the manufacturing sector adding jobs at a rate of 15,000 to 20,000 per month.

For more on the PMI and its relevance to investors, please read the Market Realist series Why do key purchasing managers’ index readings move markets?

How do key industrial stocks impact PMI readings?

The PMI readings reflect manufacturing activity upswings and downswings and are based on surveys conducted in the manufacturing and industrials sector. An increase or decrease in manufacturing activity will affect ETFs like the iShares U.S. Industrials ETF (IYJ), which tracks the performance of the Dow Jones U.S. Industrials Index. IYJ invests in domestic companies in the construction, manufacturing, and industrials sectors. With an expense ratio of 0.46%, IYJ has 221 holdings and Assets Under Management (or AUM) of ~$946 million. The top ten holdings in IJY include General Electric (GE) and United Technologies (UTX).

Both General Electric (GE) and United Technologies (UTX) have delivered excellent results in Q1 2014. GE’s industrial segment reported a 12% year-on-year gain in operating profits for the quarter to $3.3 billion, with the oil and gas segment powering the increase. United Technologies (UTX), which reported Q1 results on April 22, raised full-year EPS guidance for 2014 from $6.55–$6.85 to $6.65–$6.85. All five of the UTX segments reported increased organic sales and the company reported first quarter sales of $14.75 billion on organic sales growth of 5%.

Outlook

Although manufacturing looks set to expand, the other indices, like the prices and the employment indices, will be of keen interest to markets. Price increases or decreases and the pace of job growth will determine base rate increases in the future. Inflation at the 2% level as well as labor market recovery, are the pillars of the Fed’s twin mandate of ensuring price stability along with economic growth.

Base rate increases or increases in the Fed funds rate would increase rates across other maturities as well, all else equal. This would impact bond returns, as bond prices move inversely to interest rates. Investors can benefit from rising rates by investing in inverse fixed income ETFs 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.

In the next part of this series, we’ll preview the construction spending report for March, which will be released by the U.S. Census Bureau on Thursday, May 1.

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