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Changes in the ISM manufacturing index often mean nothing [ClearOnMoney]
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Changes in the ISM manufacturing index often mean nothing

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Commentary

Changes in the ISM manufacturing index often mean nothing

2 Jun 2010 by Jim Fickett.

With everyone on edge about whether the recovery will slow, much attention was paid on Tuesday to small decreases in the ISM manufacturing index, or PMI, for the US, and the two PMIs for China. However even large changes in the PMI are compatible with steady growth in actual manufacturing production, and small changes are noise.

A strange thing about finance and investing is the extent to which numbers are often accepted at face value, with few questions asked about supposed implications.

The ISM manufacturing index, or PMI, is meant to measure growth in manufacturing, with 50 being the neutral value and higher values indicating higher rates of growth. Small changes in the PMI are usually taken to have great significance. For example, Marketwatch reported on Tuesday,

Activity in U.S. manufacturing slowed a bit in May after hitting a six-year high in April but still showed considerable momentum, according to a closely followed survey of top executives released Monday.

The Institute for Supply Management index fell to 59.7% in May from 60.4% in April. This was above the 59% reading expected by economists surveyed by MarketWatch. …

Readings over 50% in the ISM diffusion index indicate that more firms are growing than contracting.

Stocks clawed back into positive territory after the ISM report was released.

So according to Marketwatch (and most other news sources) a change in the PMI from 60.4% to 59.7% tells you something of substance.

The graph below shows the ISM manufacturing index (vertical blue bars), the manufacturing subindex of the Index of Industrial Production (black line), and GDP (red line). (GDP is not the main point here, but is included as a check on the ISM statement that “A PMI in excess of 42 percent, over a period of time, generally indicates an expansion of the overall economy.” Monthly values are averaged and plotted quarterly. Click for larger image.)

Clearly there is significant correlation between the height of the blue bars and the slope of the black line, as claimed.

But look, just for example, at the area in the box. The PMI varied greatly (certainly much more than the change from 60.4% last month to 59.7% this month), and even flipped back and forth between indicating growth and slowdown, while the actual production of the manufacturing sector grew quite steadily.

In short, if there are large changes in the PMI, it is a hint that something is really happening in the manufacturing sector, but certainly no guarantee. Small changes should be ignored.

China's growth is much in the spotlight, so a similar small decrease in both PMI's for China caused quite a stir. The Wall Street Journal reported,

Sentiment was initially dented by worries over Purchasing Managers Index data showing that the Chinese economy was still expanding, though at a slower pace than before. …

Patersons senior private client adviser Chris Blair in Sydney said the concerns were overdone and that the modest cooling in China's manufacturing expansion is a good outcome …

“China wants to slow its economy to sustain it so it doesn't blow up…you can't look at those PMI figures and say some cooling is disappointing, because it shows that their policy steps are working. The market is just jumping at shadows,” Blair said. …

Earlier Tuesday, the China Federation of Logistics and Purchasing, said that China's PMI fell to 53.9 in May from 55.7 in April. HSBC's own PMI gauge for China also fell to 52.7 in May from a revised 55.2 in April.

HSBC economist Qu Hongbin said the lower PMI readings “should be seen as positive as it implies that policy tightening is starting to take effect. China's overheated growth is already starting to cool down.”

I agree that some slowing in China's economy would be a good thing, and I would love to know whether that is happening. But this does not tell us.

Noise does, of course, move markets, but it is still noise.

~~DISCUSSION~~