This Obscure Economic Report is Signaling Trouble

About a year ago I wrote an article about economic reports.

The bottom line of the article was that reports don’t matter, until they matter. (Or put another way — like my money supply example in the article — they matter until they don’t.) 

These days, the reports that “matter” at any given time are the ones that the reflect the economy most at any moment. The biggest factor that impacts markets is the Fed. Their job, according to them, is to promote price stability, aka low inflation, and economic growth which they like to measure by employment.

That puts these two reports at the top of the “rockstar” chain. But there are less glamorous reports that are well worth paying attention to. 

So I wanted to offer the occasional column on economic reports that you should be keeping an eye on. 

I’ve got a little known report to share with you today…

Meet the Purchasing Managers’ Index

The Purchasing Managers’ Index or PMI is a ridiculously simple report (from a math perspective). Yet it also offers potentially very valuable insight into the performance of the economy.

Why should this report be considered such a golden resource? 

Because of the source of the data. Purchasing Managers are literally at the center of their company’s universe. They need to know just about everything that’s going on inside a company. Is a company going on a hiring spree thanks to an expansion? They’ll need to make sure they have whatever they need to support new hires. Big marketing push coming up? They have to know because they’ll need to make sure there’s inventory. 

The Big Reports

There are actually multiple economic groups that report purchasing manager feedback. 

The two biggest (and most watched) are the Institute for Supply Management (ISM) and IHS Markit (which is now part of S&P Global).

ISM has been surveying purchasing managers since 1948 while Markit has been on the job since 1959 so both have a deep background producing their reports.

Both operate in pretty much the same manner.  They select companies they consider representative of the economy as a whole as well as particular industries and send out a simple survey every month. (ISM tends to favor bigger sized companies while Markit surveys more smaller and mid-sized companies to give a little broader picture.)

Both collect data in similar manners but here’s how Markit describes their process:

In terms of collecting the data, it’s a very simple question that we ask. The one example here is this: Please compare the level of output at your company with the situation one month ago, is it higher, the same or lower?

Then the participant just checks a box.

Now, each of these responses are given a weight. So, the percentage of the survey panel that reported higher is given a weight of one and the percent that was reporting the same gets given a weight of naught point five, and no weight goes to those reporting lower.

Then they add it all up. If 100% reported no change, the score would be 100% x 0.5 or…  50!  

One of the big  advantages of the Purchasing Managers Index is that it’s probably as close to a real time indicator of the economic cycle as you can get. You see how things are developing inside businesses from month to month. 

One of the downsides is that the data is represented as a “diffusion index.” That means it just adds up and weights the answers without any kind of context. In other words if one surveyed company indicated their employment situation improved because they hired 3 new employees while another’s was worse because they laid off 150… that’s net neutral. 

Reading the Reports

Reading the reports is simple… Any print above 50 indicates growth and below 50 means contraction. It’s that simple. 

So what did we see for August?

ISM Non-Manufacturing PMI

Source: Tradingeconomics.com

IHS Markit US Services PMI

Source: Tradingeconomics.com

We’ve got a very interesting divergence between the two reporting services. While both are firmly in trends lower, ISM is still above 50 and showing a little recent strength. Markit, on the other hand, is substantially weaker below 50. 

Dramatic divergences like these usually signal a dramatic move in the making. 

Let’s keep an eye on these…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Daily