Purchasing Manager Survey Says... Compiled by: Erik Kruse, SCRC

Business people have long used survey-based reports to observe markets and aid forecasting. In this regard, reports of purchasing manager surveys, in particular, are popular because they quickly furnish both macroeconomic and specific market insights from the people serving on the front lines of business and industry. One such report is the Institute for Supply Management’s (ISM) Manufacturing Report on Business, which is based on a survey of purchasing and supply executives in over 400 industrial companies. In fact, an author in Purchasing magazine called this report “the granddaddy of them all.” The centerpiece of the report is the Purchasing Manager’s Index (PMI).

PMI Background
The ISM was founded in 1915 and has published the report and the PMI since 1939 (since 1948 on an uninterrupted basis). The PMI is a composite index based on the seasonally adjusted diffusion indexes for five indicators with varying weights: New Orders represents 30 percent, Production represents 25 percent, Employment represents 20 percent, Supplier Deliveries represents 15 percent, and Inventories represents 10 percent. It is viewed widely as a major leading indicator of both manufacturing and overall economic growth.

PMI Interpretation
The index is seen as an early indicator of what is happening in the general economy. In fact, a regression analysis by the U.S. Department of Commerce that associates GDP growth rates with various PMI levels allows the ISM to claim (1) that “a PMI over 42.7 percent, over a period of time, indicates that the overall economy, or Gross Domestic Product (GDP), is generally expanding; below 42.7 percent, that it is generally declining.” Additionally, a PMI reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent that it is generally declining.” Besides simply showing the direction of change, the figure also shows the magnitude of expansion or decline.

PMI Popularity
The PMI is highly regarded because the ISM report is released relatively quickly, and the index is generally considered to be accurate and easy to interpret. As a Purchasing author wrote, “it is widely believed that purchasing managers, by virtue of their jobs, have very early access to hard data about their company’s performance for a particular month.” For this reason, the ISM is able to release its manufacturing data on the first day of every month for the month immediately prior. In fact, the report is released at least two weeks before comparable government economic statistics (1).

PMI Seasonality Adjustment
The ISM Manufacturing Report on Business makes use of seasonal adjustment factors. While seasonal factors are especially influential during the transition from late summer to fall, in most months the influence is not very large. The ISM periodically reviews its methodology, including the use of seasonal adjustment factors. These are updated by the U.S. Department of Commerce on a yearly basis. For example, for its January 2003 and subsequent reports, ISM switched to a new methodology. Regarding the recent switch, ISM stated: “all series were reviewed to determine if additional series could be adjusted and if formerly adjusted series should continue to be adjusted. The analysis resulted in adding seasonal adjustments to some series and dropping it from others.”

PMI Predictions
The author of an article published in the Journal of Purchasing & Materials Management examined several ways to estimate future PMI values. According to the author, “the best results come from simply using the current period’s New Orders data to estimate the next month’s PMI. New Orders is a consistently reliable indicator one or two periods in advance of an actual change in the direction of the economy (2).”

In addition, other PMIs may shed light on the national PMI. Regional reports, such as Philadelphia, Chicago, Milwaukee, Detroit, and New York, all precede the release of the national survey. A Lycos reported on the usefulness of these indices, based on their ability to aid in forecasting the national index. In this report, the Chicago and Philadelphia PMIs were found to have the best correlation with ISM’s national PMI. Chicago and Philadelphia had correlations of 91 percent and 76 percent, respectively.

References:

(1) Porter, A. (December, 2002). Trend Spotting. Purchasing.

(4) Raedels, A. (Fall, 1990). Forecasting the NAPM purchasing managers’ index. Journal of Purchasing & Materials Management.

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