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Manufacturing activity corresponds to 4% economic growth in May

Brent Nyitray, CFA, MBA

May 2014 Institute for Supply Management surveys: Key points (Part 1 of 4)

The Institute for Supply Management Index assesses the outlook of manufacturing in the U.S.

The Institute for Supply Management Purchasing Manager’s Index (ISM PMI for short) 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 REITs will correlate, particularly those in the logistics space, like Prologis (PLD).

Manufacturing activity has been generally improving all year, although the index has been somewhat volatile as of late

The Index of Overall Activity rose to 55.4 in May, an increase from the April reading of 54.9. New orders and production drove the increase. Employment fell to 52.8 from 54.7, which was a disappointment. Prices rose and the trend is towards an acceleration of prices. A total of 17 industrial sectors reported growth, while one reported contraction.

You can use PMI to predict GDP growth. The current level for May (55.4) would correspond to a 4% increase in GDP. The average from January to May (53.7) would correspond to a GDP growth rate of 3.5%. Of course, manufacturing doesn’t have the weight it used to, but still these are incredibly bullish numbers. This may explain why the Fed believes employment numbers are going to get better, which is why it’s 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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