Why Purchasing Managers’ Indexes have become closely watched economic indicators

Early this year, the pandemic hastened most of the world’s major economies into recessions. But over the summer and into the fall, indicators showed that many of these economies were sharply rebounding from the deep trough they had fallen into a few months earlier.

Why Purchasing Managers’ Indexes have become closely watched economic indicators

While many economists are split over whether these partial recoveries will prove to be sustainable for the long haul, one thing is for certain: The outlook is continuously changing. If you’ve been following economic news recently, you may have come across the term Purchasing Managers’ Index (PMI). But what is a PMI, and why has it become an important tool to study the economy?

What is a PMI and why do PMIs matter?

Investors use different types of indexes and data to gauge different aspects of the economy. For example, government-issued monthly reports on job growth and unemployment are closely watched indicators of the labor market’s health, and quarterly gross domestic product reports assess the state of the overall economy by measuring the value of the goods and services that a country produces. In recent years, PMIs have attracted more attention as key indicators of the manufacturing and services sectors of countries’ economies.

PMIs track the prevailing direction of trends in manufacturing and services. They do this by summarizing the outlook of corporate purchasing managers, who are in a good position to know whether economic activity within their industries and among their suppliers and customers is expanding, remaining mostly static, or contracting. Purchasing managers are tasked with balancing inventories with the need for raw materials, parts, and other supplies, and their ordering decisions can be critical to their company’s success in maintaining an efficient supply chain that meets customer demand without building up excess inventory. As a result, purchasing managers become adept at making forecasts and tracking trends—the characteristics that underlie measures known as leading economic indicators, which offer insight into what to expect, rather than what’s already happened.

In contrast, lagging indicators such as GDP are historical data, which means they tell us how an economy fared over a certain period of time (either in quarters or annually) in the past. PMIs offer forward-looking data, which helps understand changes that are happening currently, and at a much quicker cadence than GDP numbers. PMI data is released on the first business day of every month after the month for which the PMI has been calculated.

PMIs are on an uneven recovery path after a sharp decline

How are PMIs measured?

In the United States, the Institute for Supply and Management, an association of supply management professionals in more than 90 countries,1 compiles PMI reports every month for the manufacturing sector and for the services sectors. On the manufacturing side, a survey is sent to senior executives at around 400 companies across 19 industries. These 400 companies are chosen and weighted in reference to their contribution to the country’s GDP. The survey is made up of five key areas: inventory levels, production, supplier deliveries, employment, and new orders. Each area is weighted equally and given a certain value for either improvement, no change, or deterioration.

PMIs aren’t exclusive to the United States; they’re compiled by IHS Markit, a business information provider, for more than 40 economies worldwide. 2

The PMI is a number between 0 and 100. When the PMI number is above 50, it denotes an expansion in reference to the earlier month. If the PMI number is below 50, it denotes a contraction, while a PMI reading of 50 means there’s no change.

Strengths and weaknesses of PMIs as economic indicators

Now that we know what a PMI is and how it works, let’s explore some of the reasons why PMIs can serve as useful indicators for economists and investors to track the broader economy. One strength of the PMI is that it’s timely. Since the data is released monthly, it helps provide a more current snapshot of economic conditions than quarterly indicators. Secondly, since a PMI is condensed to one single number, it’s easy to compare from month to month, and it’s simple to grasp. 

That said, PMIs have their weaknesses and shouldn’t be considered indicators of the broader economy. For one, manufacturing PMIs only focus on the manufacturing sector. In the United States, manufacturing’s role in the broader economy has been decreasing with the expansion of the services sector. So, looking at the manufacturing industry alone might not always provide a realistic take on the economy’s health.

All things said, even though PMIs have their limitations as economic indicators, it’s likely that they’ll continue to be closely watched as the global economy continues to try to regain its footing in the wake of the pandemic’s damaging impact.

 

1 Institute for Supply Management, 2020 2 IHS Markit, 2020.