We are a nation of industry, and for decades this has been the overall measurement of an economy's health. Nations that have high levels of manufacturing, generally have high national growth rates. However, as we've mentioned many times, high GDP growth rates do not necessarily mean that one economy is generally better than another.
On this edition of Macro Mondays, I thought it would be a good idea to talk about the monthly report that has many economists in a huff: the ISM Manufacturing Index. Just a glance over this report each month can tell you a lot about the state of the US economy, especially when it comes to strength in industry. Check out the details below and be sure to check out Investopedia's page for even more macro economic know-hows.
What is the 'ISM Manufacturing Index'?
The ISM Manufacturing Index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production, inventories, new orders and supplier deliveries. A composite diffusion index monitors conditions in national manufacturing and is based on the data from these surveys.
Why do investors care?
The ISM Manufacturing Index is one of the first pieces of news released each month, so it can greatly influence the tone of investor and business confidence. It also a survey of purchasing managers who are at the forefront of their companies' supply chains. Manufacturers need to respond quickly to changes in demand, and they ramp up or scale back purchases of inputs to match demand. As a result of their position in the company, they are perhaps better positioned than anyone to speak to the ebb and flow of business conditions.By monitoring the ISM Manufacturing Index, investors can better understand national economic conditions. When this index is increasing, investors can assume that the stock markets should increase because of higher corporate profits. The opposite can be thought of the bond markets, which may decrease as the ISM Manufacturing Index increases because of sensitivity to potential inflation.
How is the index constructed?
The ISM Manufacturing index is based on data compiled from a nationwide survey of purchasing and supply management executives. The survey is broadly diversified across industries based on the North American Industry Classification System (NAICS), weighted by each industry's share of U.S. gross domestic product (GDP). Survey responses are delineated into 17 NAICS codes, including 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 staying the same. The activities include new orders, production, employment, supplier deliveries, inventories, customers' inventories, commodity prices, backlog of orders, new export orders and imports. For each of the 19 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. A composite manufacturing index is calculated by taking an equal 20% weighting for five categories devised from the 10 survey questions: new orders, production, employment, supplier deliveries and inventories. For the sub-indices and composite index, a reading of greater than 50 signals increased economic activity, less than 50 indicates a contraction and 50 corresponds to no change.
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