What Is the ISM Manufacturing Index?
The ISM Manufacturing Index is a widely-watched indicator of recent U.S. economic activity. The index is often referred to as the Purchasing Manager's Index (PMI).
Based on a survey of purchasing managers at more than 300 manufacturing firms by the Institute for Supply Management (ISM), the index monitors changes in production levels from month to month. The index is the core of the ISM Manufacturing Report.
The ISM Manufacturing Index Explained
The PMI is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories. Each factor is seasonally adjusted.
A PMI Index of more than 50 indicates expansion of the manufacturing segment of the economy in comparison with the previous month. A reading of 50 indicates no change. A reading below 50 suggests a contraction of the manufacturing sector.
The Impact of the ISM Manufacturing Index
The monthly announcement of the ISM Manufacturing Index can greatly influence investor and business confidence. This is because the index is a survey of purchasing managers and supply management executives who are at the forefront of their companies' supply chains.
Purchasing managers are in the best position to assess the ebb and flow of business conditions. Manufacturers must respond quickly to changes in demand, ramping up or scaling back purchases of materials they use in anticipation of demand for their finished products.
The ISM Manufacturing Report is released on the first business day of each month and is thus one of the earliest indicators of economic activity that investors and business people get regularly. (A separate ISM Non-Manufacturing Report is released a few days later.) The institute also releases a Semi-Annual Economic Forecast in May and December.
By monitoring the ISM Manufacturing Index, investors can better understand national economic trends and conditions. When the index is rising, investors anticipate a bullish stock market in reaction to higher corporate profits. The opposite is the case in the bond markets, which may fall as the ISM Manufacturing Index rises because of the sensitivity of bonds to inflation.
- Stock traders eagerly await the index on the first business day of each month.
- The index indicates the direction of the economy based on recent manufacturing activity.
- A number above 50 indicates a growing manufacturing sector.
How the Index Is Constructed
The ISM survey is broadly diversified across industries based on the North American Industry Classification System (NAICS), which is weighted by each industry's share of U.S. gross domestic product (GDP). Survey responses are delineated into 17 industry sectors such as chemical products, computer, and electronic products, and transportation equipment.
Survey respondents are asked whether activities in their organizations are increasing, decreasing, or stagnant. The activities include new orders, production, employment, supplier deliveries, inventories, customers' inventories, commodity prices, order backlog, new export orders, and imports.
For each of the categories, a diffusion index is calculated by adding the percentage of respondents reporting an increase to half of the percentage of respondents reporting no change. The composite manufacturing index is calculated by taking an equal 20% weighting for five categories of questions on new orders, production, employment, supplier deliveries, and inventories.
The PMI has been calculated and published monthly since 1948 by the ISM, a not-for-profit professional association.