Why July 2014's ISM releases were good news for REITs and builders (Part 1 of 4)
The ISM Index assesses the outlook of manufacturing in the U.S.
The Institute for Supply Management (or ISM) Purchasing Manager’s Index (or PMI) is similar to the other regional PMI indices, but it covers the entire country. The ISM PMI looks at various business indices, like new orders, production, employment, supplier deliveries, inventory, customer inventories, prices, backlog, exports and imports, and capital expenditures. A reading over 50 means manufacturing is generally expanding. A reading over 42 shows the economy in general is expanding.
Many industries watch manufacturing activity in order to predict growth
Any economically sensitive business, especially cyclical businesses, wants to pay attention to the ISM data. Homebuilders like Lennar (LEN), D.R Horton ( DHI ), Toll Brothers (TOL), and PulteGroup (PHM) are particularly cyclical and will correlate with manufacturing activity. Even some of the commercial Real Estate Investment Trusts (or REITs) will correlate, particularly those in the logistics space, like Prologis (PLD).
Manufacturing activity has been generally improving all year
The Index of Overall Activity rose to 57.1 in July—a 1.8 percentage point increase from the June reading of 55.3. New orders and production drove the increase, as both were above 60. Employment rose to 58.2. Prices increased and the trend is towards a deceleration of prices. A total of 17 industrial sectors reported growth, while one sector (Wood Products) reported contraction.
You can use the PMI to predict gross domestic product (or GDP) growth. The current level for July, 57.1, would correspond to a 4.6% increase in GDP. The average from January to July, 54.4, would correspond to a GDP growth rate of 3.7%. Of course, manufacturing doesn’t have the weight it used to. But these are still incredibly bullish numbers.
This may explain why the Fed believes employment numbers are going to get better. This means that investors have to start thinking about how to react when the Fed starts increasing rates.
Browse this series on Market Realist:
- Part 2 - Connecting the dots: Why manufacturing affects homebuilders
- Part 3 - Must-know: Why the ISM Non-Manufacturing Index surged in July
- Part 4 - Why rising employment should lower office REIT vacancy rates