INSTITUTE FOR SUPPLY MANAGEMENT (ISM)

MANUFACTURING SURVEY

Market Sensitivity: Very high.

What Is It: First monthly report on the economy with a focus on manufacturing.

News Release on Internet: www.ism.ws/ISMReport/index.cfm

Home Web Address: www.ism.ws

Release Time: 10 A.M. (ET); released the first business day after the reporting month.

Frequency: Monthly.

Source: Institute for Supply Management.

Revisions: No monthly revisions are done, but every January there are reassessments of seasonal adjustment factors that san lead to changes in all the data.

WHY IS IT IMPORTANT

You might choose to ignore this economic indicator because of its less-than-riveting name. So here’s a warning: Don’t! It is the first piece of news on the economy out of the gate every month and the most influential statistic released by the private sector. The organization behind this market-moving series is the Institute for Supply Management (ISM), a Tempe, Arizona-based group that represents corporate purchasing managers around the country. Indeed, prior to January 2002, it was known by the more transparent name of National Association of Purchasing Managers. The ISM put out two major surveys each month. The first is based on comments from purchasing managers in the manufacturing sector. The second deals with their counterparts in the non-manufacturing, or service, industry. It is the manufacturing survey that grabs most of the attention in the financial markets and the press.

This raises an immediate question. How is it that an obscure bunch of purchasing managers in manufacturing can hold such sway over the investment community? The answer can be found by understanding what corporate purchasing agents do. Manufacturing companies need lots of supplies to make products. Those in charge of procuring this material for their company are purchasing managers. A sample of items they might order includes wiring, packing boxes, ink, and computers. If there is a pickup in demand for manufactured products, purchasing managers respond by increasing orders for production material and other supplies. Should manufacturing sales slow, these corporate buyers will cut back on industrial orders. Thus, by virtue of their position, purchasing managers are in the forefront of monitoring activity in manufacturing. That’s important because the goods-producing industry is highly sensitive to the ebb and flow of business in the broader economy. Best of all about the ISM’s Purchasing Managers Index is its timing. Survey results come out on the first business day of every month. As such, they provide the earliest clues of how the economy has fared during the previous four weeks. Indeed, the numbers are so current the Federal Reserve officials are briefed on the data before the public sees it. The ISM’s non-manufacturing report (see the next section) comes out two business days later, but it has not yet achieved the exalted status of the manufacturing release.

HOW IS IT COMPUTED

The ISM’s manufacturing survey has an interesting history. Its origin can be traced to Herbert Hoover. Faced with a collapsing U.S. economy during the Great Depression, President Hoover was frustrated by the lack of current data on the health of American manufacturers. He approached the ISM, then known as the National Association of Purchasing Agents, and urged them to develop a survey that would provide up-to-date information on the health of this important part of the economy. The group complied, and the survey began in 1931. It has been around ever since, except for a brief four-year interruption during World War II.

Nowadays, the ISM mails out questionnaires every month to about 400 member companies around the country, representing 20 different industries. Corporate purchasing managers are asked to assess if activity is rising, falling or unchanged in the following field:

• New orders: New orders by purchasing agents

• Production: Manufacturing output

• Employment: Hiring in the company

• Supplier deliveries (or vendor performance): Speed of delivery from suppliers

• Inventories: The rate of liquidating manufacturer’s inventories

• Customers’ inventories: Agents guess the inventory levels of their customers

• Commodity prices: Prices paid by manufacturers for supplies

• Backlog of orders: Orders not yet filled

• New export orders: Rate of new orders from other countries

• Import: Material that agents purchased from other countries

(Seasonal adjustment factors are applied on new orders, production, employment,

supplier deliveries, inventories, export orders, and imports.)

The Purchasing Managers Index (PMI) itself is a compilation based on answers to the first five queries in the preceding list. They are weighted as follows to compute the index: new orders (30%), manufacturing production (25%), employment (20%), supplier deliveries (15%), and inventories (10%). The bottom five provide additional coverage on how manufacturing is performing. The PMI is calculated as a so-called diffusion index, which shows changes in activity from month to month, but not actual levels of production. As the responses from members come in, the ISM takes the percentage of those who reported activity being higher in each component and adds that to half the percentage of those who reported seeing no charges. If the result is an index number above 50, it means the manufacturing sector is growing. Below 50 means it’s contracting. An index of 50 represents no change in activity.

Here are two examples: Let’s say 100% of those surveyed reported no change in manufacturing production. To come up with the index, take half the percentage of those who said orders were unchanged (which gives you 50%) and add it to the percentage of agents who saw higher activity (no one did, so it’s 0%). The result is an index of 50, which means that purchasing managers have seen no discernible change in manufacturing output from one month to the next.

In the second example, we’ll assume 30% of the agents reported higher activity, while 50% noticed no change in business. The diffusion index in this case comes to 55% (30 plus half of 50), which is a sign manufacturing output is expanding.

MARKET IMPACT

If the economy is fundamentally healthy and inflation is in check, the dollar will likely bounce higher with a PMI above 50. Conversely, should the ISM report portray a manufacturing sector teetering on recession, foreigners might sell some of their dollar-linked investments, depressing the greenback’s value against other key currencies.