1. One of the most reliable leading indicators for assessing the state of the economy is the PMI, formerly known as the Purchasing Managers' Index.
2. Members receive a monthly questionnaire that asks them to identify month-over-month changes for the following ten business activities that also constitute individual indexes in the Report on Business survey。
3. The most common answers include:
-Improvement
-No change
-Deterioration
INDEXES
1. New orders – from customers
2. Production – rate and direction of change in the level of production
3. Employment – whether increased or decreased
4. Supplier deliveries – are they slower or faster?
5. Inventories – increases or decreases in stockpiles
6. Customer Inventories – rates the level of inventories held by the organization’s customers
7. Prices – reports whether organizations are paying more or less for products & services
8. Backlog of Orders – measures whether the order backlog is growing or declining
9. New Export Orders – measures the level of export orders
10. Imports – measures the rate of change in imported materials
PMI CALCULATION
1. The PMI is a composite index based on equal weights (20%) of the following five primary sub-indexes – New Orders, Production, Employment, Supplier Deliveries, and Inventories.
2. survey respondents are asked to indicate whether it has become better, worse, or has stayed the same, as compared to the previous month. The individual indexes for each business activity such as production, employment, etc. are calculated by taking the percentage of respondents who report that the activity has improved (i.e. is higher or better) and adding it to one-half of the percentage who report unchanged activity.
3. For example, if 40% of the respondents report that employment, say, has increased, while 35% report no change and 25% report a decrease, the diffusion index would be: (40% + [0.5 x 35%]) = 57.5%.
4. A reading of 50% indicates no change from the preceding month, while the further away the index reading is from 50%, the greater the rate of change. A reading of 100 indicates that all survey respondents are reporting increased activity – as may be the case in an exceptionally strong economy – while a reading of 0 indicates that all respondents are reporting decreased activity.
INTERPRETATION
1. A PMI reading over 50 or 50% indicates growth or expansion of the U.S. manufacturing sector as compared to the previous month, while a reading under 50 suggests contraction.
2. A reading at 50 indicates that the number of manufacturers reporting better business is equal to those stating business is worse.
STRENGTHS AND WEAKNESSES OF PMI
1. The PMI is a timely indicator, as it is released on the first day of the month after the one in which the survey was conducted.
2. Accurate leading indicator on the state of the U.S. economy.
3. The PMI condenses the health of the manufacturing sector into a single number, while the Report on Business contains a wealth of information on main business activities.
4. The PMI only covers the manufacturing sector, whose importance to some economy has been diminishing over the years.
SIGNALS
1. Key number to watch is 43.2, since a PMI index above this level over a period of time indicates an expansion of the overall economy.
2. Meanwhile, a sustained reading of below 42.0 could indicate that an economy is heading into a recession.
3. The bond markets watch the growth in supplier deliveries and prices paid, since these figures can provide insight into the potential for inflation. Since bonds are fixed-income assets, inflation has a detrimental effect that can erode their prices. Investors interested in specific sectors may also look at the purchasing trends within their specific vertical markets.
Source:
https://www.investopedia.com/articles/investing/010914/importance-purchasing-managers-index-pmi.asp
https://www.thebalance.com/what-is-the-purchasing-managers-index-pmi-1978996
