What is the ISM Manufacturing Index and its role as an indicator for the US Economy?

The ISM manufacturing index is a monthly index published (since 1948) at the beginning of the month by the Institute of Supply Management (formerly known as the National Association of Purchasing Management, Inc. (NAPM)founded in 1915 to serve supply management professionals). The index aims to gauge the relative strength of economic activity - month by month - in the US manufacturing sector, by surveying purchasing managers at over four hundred manufacturing firms across all 50 states and over 20 major industries in the US.

It is a key leading indicator of the state or health of the U.S. economy, one that is closely watched by the investors, economists, and government agencies as it reflects purchasing decisions made by purchasing managers significantly in advance to meet manufacturing forecasted needs based on consumer/business demand.

A higher trending reading in the index signals increased “relative strength” in the economy and is potentially bullish for corporate profits whereas conversely a declining trend is bearish, signaling weakness in the economy and lower corporate profits. In the case of the bond markets it may have an opposite effect as bonds may fall when the ISM Manufacturing Index rises due to the sensitivity of bonds to inflation.

What is the Composition of the Index?

Survey participants are asked whether conditions have improved, deteriorated or remained the same in 10 specific areas, or subindexes:

1. New Orders (reflects the increases and/or decreases in new orders)
2. Production  (measures the rate and direction of change, if any, in the level of production)
3. Employment (reports the rate of increase or decrease in the level of employment.
4. Supplier Deliveries (reveals if deliveries from suppliers are faster or slower)
5. Inventories (reflects the increases and/or decreases in inventory levels)
6. Supplier Deliveries (if deliveries from suppliers are faster or slower)
7. Customers’ Inventories (if customers inventories growing/declining)
8. Prices (reports whether organizations are paying more or less)
9. Backlog of Orders (whether growing or declining)
10. New Export Orders (levels of international orders)
11. Imports (rate of change in materials imported.)

The ISM manufacturing index gives equal weighting - 20% each - to the first of the five areas listed, namely production, employment, supplier deliveries, new orders, and inventories. In addition, they are also seasonally adjusted.

The ISM is a diffusion index which aims to measure the degree to which a change in something is spread out, or "diffused" among a particular group. Members are asked if something e.g., New Orders has changed and in which direction e.g., it has not changed, it has increased, or it has decreased from the previous month.

The ISM indexes are calculated by taking the percentage of respondents that report that the activity has increased ("Better") and adding it to one-half of the percentage that report the activity has not changed ("Same") and adding the two percentages.

A PMI rising trend above 50 indicates an expansion of the manufacturing segment of the economy compared to the previous month. A reading of fifty means no change. A reading that trends below 50 suggests a contraction.