The ISM PMIOne monthly survey that shows the cycle.
The ISM PMI surveys US factories every month and turns the answers into one number. It shows the phase of the economic cycle, and stocks and commodities have tended to follow it closely.
Why US factories tell you about the world
The US accounts for more than 15% of global output and is the world’s biggest consumer of goods. Many of those goods come from producers in more than 30 other countries. So when US consumption rises, the US economy and its trading partners grow with it, and when it falls, they all feel it.
That makes US manufacturing a window on the global economy. Measure how US factories are doing and you get an early read on growth in the US and, through its trading partners, in the rest of the world. That is exactly what the ISM PMI does, which makes it a monthly read on the phase of the economic cycle.
What the survey asks
PMI stands for purchasing managers’ index. Every month since 1948, the Institute for Supply Management has surveyed more than 400 companies in 20 manufacturing industries across the US. It asks about new orders, order backlogs, new export orders, imports, production, supplier deliveries, inventories, customers’ inventories, employment and prices, and turns the answers into one number.
Positive answers mean business is expanding, consumption of goods is rising and economic output with it. Negative answers point to stagnation or contraction. Over many years the index closely reflects the growth rate of the US economy, and it arrives every month, much sooner than GDP.
How to read the number
The index moves in cycles. When it reaches a high or a low, it turns and heads the other way. Around 60, the economy is growing at its fastest rate. Between 46 and 50, growth is sluggish. The lows come in the 40s, where growth turns negative.
The line that matters most is 46. When the ISM PMI has fallen below it, the US has historically slipped into a recession, roughly every 8 to 10 years. The savings bank crisis in the US in 1981 and the global financial crisis of 2007 and 2008 both came with readings below 46.
You will often hear 50 described as the line between a growing and a shrinking manufacturing sector. A reading between 46 and 50 means factories are struggling, but on its own it has not meant a recession.
The big cycle first, then the swings
The index does not travel in a straight line from low to high. The big, primary cycle runs over many years and shows the long-term direction of the economy. Inside it run smaller, secondary cycles: the medium-term ups and downs on the way from one extreme to the other.
So read it in 2 steps. First look at the big cycle over many years and decide which phase the economy is in. Once that is clear, zoom in to the last 5 years to see which smaller swing you are in, and where the economy is more likely to head next. One weak reading is not a recession, and a small bounce in a downturn is not yet a new upswing.
What stocks and commodities do
For traders, the most useful part is how closely markets follow the index. Set the ISM PMI against the return of the S&P 500 and the 2 lines move almost exactly together. Above 46, stock returns have tended to be positive. Below 46, the market expects negative growth and falling company earnings, and prices drop. Because the S&P 500 leads the world’s stock markets, the others suffer with it.
Commodities react the same way. When the ISM PMI rises, growth speeds up, demand for raw materials rises and commodity prices tend to rise. When it falls, they tend to fall. That makes the index an early warning for stock investors and a gauge of demand for anyone trading commodities or commodity currencies, such as the Canadian and the Australian dollar.
Using the monthly release
The ISM manufacturing PMI comes out early every month and is listed in the Economic Calendar. Compare it with the forecast and the previous reading, and note whether it has crossed 50 or 46.
A PMI that keeps sliding towards 46 is a warning for the S&P 500, even while prices are still high. Treat it as a reason to be more careful with long positions. It does not tell you the exact day to sell.
In short
- Every month since 1948 the ISM has surveyed more than 400 US manufacturers, and the result reflects the growth of the US and, through its trading partners, of the world.
- Around 60 growth peaks, between 46 and 50 it is sluggish, and below 46 the US has historically slipped into recession, roughly every 8 to 10 years.
- Stocks and commodities have tended to follow the index, so read the big cycle first, then the last 5 years, and check it every month.
Questions
Is there a services PMI as well?
Yes, the ISM also surveys services companies. The manufacturing index is the one used here, because of its long history and its link to global trade.
Key terms
- ISM and PMI
- Surveys that ask purchasing managers whether business is getting better or worse. Above 50 means expansion, below 50 contraction. A leading indicator.
- Economic cycle
- The repeating pattern of growth, peak, contraction and recovery that every economy goes through.
- Recession
- A period in which the economy shrinks instead of growing, usually with rising unemployment.