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Take PMI with a grain of salt [ClearOnMoney]
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Commentary

Take PMI with a grain of salt

11 Jul 2012 by Jim Fickett.

The purchasing managers index, or PMI, often figures prominently in the news as a real-time indicator of economic conditions. While it can sometimes give an early indication of changes in the business cycle, it can also sometimes be quite misleading. In particular it is a measure of direction, not of growth, and should not be relied upon too heavily.

Here is a graph of the US PMI, along with the year-over-year change in industrial production, and the year-over-year change in real GDI:

Obviously there is significant correlation between the PMI and actual measures of output. However note that sometimes, e.g. in 1995 and early 1996, the PMI goes to levels usually interpreted to mean that manufacturing is shrinking, while in fact both industrial production and GDP only slow slightly. Similarly, the PMI can give an overly rosy view of growth as, for example, in early 2004.

Such divergences are not surprising, because the PMI does not attempt to measure growth per se. Rather, it measures the fraction of companies for which conditions are improving. If a large number of companies experience a very small worsening in business conditions, output will only slow slightly, while the PMI will give a very negative reading.

The current value of the US PMI is below the neutral value of 50, but there is little reason yet to worry very much about it, as is clear from the above graph.

Since there are only so many hours in the day, the long-term investor who wants to know how the economy is actually doing should pay much more attention to industrial production and GDP/GDI than to the PMI. The PMI is mainly valuable (1) for traders, because it comes out much sooner than actual output figures, (2) in cases, like China, where solid statistics on output are not available, and (3) for those who try to invest based on the general direction of markets, since the PMI does indeed move markets.

Data notes

Nominal GDI was taken from NIPA table 1.10 and converted to real GDI by the GDP deflator in table 1.1.9. PMI historical data is available from the Institute for Supply Management. For more on the PMI see the Reference page PMI background.