Thursday, October 20, 2011

ISM Manufacturing Index

The Manufacturing ISM Report On Business, issued monthly by the Institute for Supply Management, compiles a survey of the nation’s supply executives to gauge economic activity in the manufacturing sector. The report is typically considered one of the growth barometers the market watches most closely. The results of the survey are ultimately condensed into a single percentage number, called PMI, which is scaled so that a reading greater than 50% indicates expansion while a reading below 50% indicates contraction. The September 2011 PMI came in at 51.6%, which is 1% higher than the August PMI of 50.6%. Is this enough to conclude that we've avoided a recession (at least, for now)?

To answer the question we looked at the track record of this indicator versus real GDP growth since 1949. Overall, the ISM manufacturing was 'right' (being above 50% when real GDP growth was positive and below 50% when real GDP growth was negative) about 77% of the time, and 'wrong' (being above 50% when real GDP growth was negative and below 50% when real GDP growth was positive) about 23% of time. Moreover, we found that the probability of the indicator being right or wrong was consistent across periods of positive and negative real GDP growth; this means that the ISM Manufacturing was above 50% 23% of the time when real GDP growth was actually negative. In fact, we found that historically the index was as high as 63.5 during periods of negative real GDP growth. This is certainly a less than impressive track record. Especially given that the September 2011 reading cleared the 50% mark by a margin as slim as 1.6%, we do not regard this as sufficient evidence to conclude that the risks of a recession have decreased.