U.S. Markets closed

Why incredibly bullish manufacturing numbers help homebuilders

Brent Nyitray, CFA, MBA

Key takeaways for March's Institute for Supply Management release (Part 1 of 4)

The Institute for Supply Management Index assesses the outlook of manufacturing in the United States

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), KB Home (KBH), Toll Brothers (TOL), Standard Pacific (SPF), 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, with just one sequester-driven contraction in May 2013

The index of overall activity rose to 53.7 in March, after peaking at 57 in November, the highest level since 2011. New orders and production drove the increase. Employment fell. Prices fell as raw material prices decreased, and the trend is towards moderation in prices. Employment registered 51.1—still positive, but growth is decelerating. Fourteen industrial sectors reported growth, while three reported contraction.

You can use PMI to predict GDP growth. The current level for March (53.7) would correspond to a 3.5% increase in GDP. The average from January to March (52.7) would correspond to a GDP growth rate of 3.1%. 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.

Continue to Part 2

Browse this series on Market Realist: