4/2/2024

Purchasing Managers’ Index: how does it work?

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Investors received strong data on the US economy this week. Namely, the index of business activity in US industry rose to 50.3% in March, which turned out to be higher than analysts’ forecasts. This one event has reduced the optimism of financial players about lowering interest rates, although no less important macro statistics are expected this week – the monthly report on unemployment in the United States. Therefore, it’s time to analyze this indicator in more detail.

PMI is an indicator that reflects prevailing economic trends in the manufacturing and services sectors. It is based on a diffusion index that summarizes purchasing managers’ responses to whether market conditions are expanding, remaining the same, or contracting. The purpose of PMI is to provide company decision makers, analysts and investors with information about current and future business conditions.

Prioritization of PMI

The PMI is one of the most reliable leading indicators of the health of the US economy. It is used to assess the business environment in both manufacturing and service industries. A separate PMI for the hospital sector is also published monthly.

The PMI is a composite measure based on surveys of executives at more than 400 companies in 19 major industries. The survey is conducted and published by the Institute for Supply Management (ISM). The results are weighted by each industry’s contribution to U.S. gross domestic product (GDP).

The survey contains questions about business conditions and any changes in them – improvement, deterioration or lack of dynamics. PMI is calculated based on five main indicators, each of which has equal weight: 1) new orders; 2) inventory levels; 3) production; 4) deliveries; 5) employment.

The PMI value is a number between 0 and 100.

  • A PMI above 50 indicates an increase in business activity compared to the previous month;
  • A PMI below 50 means it is contracting;
  • A PMI reading of 50 indicates no change.

PMI usage

PMI and data collected from the Institute for Supply Management’s (ISM) monthly surveys are valuable tools used to guide decision-making by key industry decision makers.

Corporate managers. Company management can use monthly PMI data to make key business decisions. For example, an automobile manufacturer may make production decisions based on forecasts of new orders from customers for future months.

These forecasts, in turn, guide management decisions about purchasing dozens of components and raw materials such as steel and plastics. This takes into account existing inventory balances, which affect the production volume required to fulfill new orders and maintain inventory at the end of the month.

Suppliers. Suppliers also use PMI. For example, a parts supplier to an automobile manufacturer might track PMI to estimate future demand for its products. In addition, it is important for the supplier to know the inventory levels of their customers, as this affects the volume of products they need to produce.

PMI information about market supply and demand influences the prices that suppliers can charge. Thus, if the number of new orders from a manufacturer increases, it can increase prices for its customers and agree to higher prices from its suppliers. Conversely, when the number of new orders decreases, the manufacturer may need to reduce prices and help reduce the cost of purchased parts.

Investors. The PMI is a valuable tool for investors because it is a leading indicator of economic conditions. Typically, PMI trends precede changes in trends in key measures of economic activity and output such as GDP, industrial production and employment. Analyzing the values and dynamics of the PMI index allows investors to predict future trends in the economy as a whole with a high degree of accuracy.

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