Why manufacturing corresponds to a 3.6% growth rate in June

Market Realist

Must-know: Institute for Supply Management surveys—June 2014 (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 indicates 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 fell to 55.3 in June—a slight decrease from the May reading of 55.4. New orders and production drove the increase. Employment was flat at 52.8. Prices increased and the trend is towards a deceleration of prices. A total of 15 industrial sectors reported growth, while three reported contraction.

You can use the PMI to predict gross domestic product (or GDP) growth. The current level for June, 55.3, would correspond to a 3.6% increase in GDP. The average from January to June, 54, would correspond to a GDP growth rate of 4%. 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. As a result, the Fed is concentrating on tapering quantitative easing and beginning to introduce the market to the possibility of higher short-term interest rates.

Continue to Part 2

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