What is the ISM manufacturing index?

The ISM manufacturing index is an economic indicator that measures the health of the manufacturing sector in the U.S. Based on a survey of purchasing managers across various industries, the monthly index tracks factors like new orders, production levels, and inventories.

Why is the ISM manufacturing index important?

The Institute for Supply Management (ISM) manufacturing index, also known as the purchasing managers’ index (PMI), is a monthly economic indicator that measures the health of the manufacturing sector in the United States.

The index is based on a survey of purchasing managers and manufacturing supply executives from over 400 manufacturing companies across various industries. It measures the change in factors such as new orders, production levels, employment, supplier deliveries, and inventories. A reading above 50 indicates expansion in manufacturing activity, while a reading below 50 signals contraction.

As a leading economic indicator, the ISM manufacturing index is closely monitored by economists, investors, government, and business leaders. It is released monthly on the first business day at 10 a.m. Eastern Time, providing investors and decision-makers with early insights into the state of the U.S. economy.

How is the ISM manufacturing index calculated?

The ISM manufacturing index is calculated using data from a monthly survey conducted by the ISM. Purchasing managers and supply executives across 20 industries in the manufacturing sector are asked to assess whether conditions have improved, remained unchanged, or deteriorated across five key activities:

• New orders
• Production
• Employment
• Supplier deliveries
• Inventories

Each of these categories is assigned an equal 20% weighting in the overall index. The survey responses are converted into a diffusion index by adding the percentage of respondents reporting an improvement to half the percentage of respondents reporting no change. The ISM manufacturing index is then calculated as a weighted average of these diffusion indices.

The survey covers 18 manufacturing industries, with the number of respondents in each industry depending on that industry’s contribution to U.S. gross domestic product (GDP). The industries represented in the ISM manufacturing index include:

• Food, beverage & tobacco products
• Textile mills
• Apparel
• Electric equipment
• Appliances & components
• Transportation equipment
• Primary metals
• Computer & electronic products
• Petroleum & coal products
• Fabricated metal products
• Chemical products.

Why the ISM manufacturing index matters for the economy

The ISM manufacturing index is a leading economic indicator that provides insights into GDP growth, employment rates, and monetary policy decisions.

GDP growth

The ISM manufacturing index has a close correlation with GDP growth. An increasing index typically reflects stronger manufacturing activity, which may contribute to economic expansion. Conversely, a declining index can signal slower manufacturing output, which could potentially indicate an economic slowdown.

Employment rates

Changes in the ISM manufacturing index can influence employment rates in the manufacturing sector. A higher index suggests strong manufacturing activity, which often leads to more hiring as businesses increase production. A lower index, however, can reflect reduced manufacturing activity, which may result in slower hiring or layoffs.

Monetary policy

The Federal Reserve uses the ISM manufacturing index as one of many indicators to guide monetary policy. A rising index could signal economic strength, prompting the Fed to consider interest rate hikes to manage inflation. Conversely, a declining index may indicate economic weakness, potentially leading to rate cuts to stimulate growth.

What factors are included in the ISM manufacturing index?

The ISM manufacturing index is based on five key areas that offer insights into the health and performance of the manufacturing economy. These are:

• New orders: This measures the volume of new purchase orders received by manufacturers. It can provide an indication of future production activity.
• Production: This tracks current production levels, reflecting the operational output of manufacturers. Higher production levels can suggest stronger demand.
• Employment: This measures the level of employment in the manufacturing sector. Rising employment levels may indicate growth in production activity, while declines could suggest reduced demand.
• Supplier deliveries: This evaluates how quickly suppliers deliver goods to manufacturers. Slower deliveries may reflect higher demand or supply chain bottlenecks, while faster deliveries could indicate reduced demand or a more efficient supply chain.
• Inventories: This measures the amount of unsold goods manufacturers have. Excess inventory may suggest lower demand, while lower inventory levels can reflect stronger sales or efficient inventory management.

How businesses can leverage the ISM manufacturing index for strategy

Businesses can leverage the ISM manufacturing index to inform strategies related to areas like inventory management, supply chain optimization, and production planning:

• Inventory management: Metrics like new orders can help businesses anticipate shifts in demand and adjust stock levels accordingly. For example, rising new orders may signal the need to increase inventory, while a decline could suggest reducing stock to prevent overstocking.
• Supply chain optimization: Supplier delivery metrics provide insights into potential delays or bottlenecks. Businesses can use this information to adjust procurement schedules and maintain smooth operations.
• Production planning: Broader trends in the index can help guide production decisions. For example, businesses may use the index to decide whether to scale up production to meet increasing demand or scale back to avoid overproduction during periods of declining activity.

This material is for informational purposes only and should not be considered as an investment recommendation or a personal recommendation.