The ISM® Report On Business® as an Economic ‘Speedometer’

The ISM^® Report On Business^® gauges sentiments of purchasing managers and supply executives, who are often said to be on the front lines of the U.S. economy. It is one of the most respected and reliable indicators among economists, bank executives and government officials, and its data helps set companies’ business models and revenue projections.

That’s why the release of the PMI^® (manufacturing sector) and NMI^® (non-manufacturing) data can elicit cheers or groans on trading floors. The latter was mostly heard on September 3, when the August PMI^® reading of 49.1 percent, the first below-50 reading in three years, added to fears of a looming economic slowdown, or even a recession. (An above-50 figure indicates growth; a below-50 number contraction.) The U.S. economy has been growing since June 2009; at 123 consecutive months, it is the longest expansion on record.

The Manufacturing ISM^® Report On Business^® is frequently cited as one of the indicators that identify a recession before it happens. “It doesn’t necessarily mean the sky is falling,” ISM CEO Thomas W. Derry says. “When the PMI^® (went below 50) three years ago in 2016, the economy didn’t go into recession. But when it dips into the contractionary area, that’s something to pay close attention to. It isn't an ironclad predictor that we're going into a recession, but it is a strong indicator.”

There have been five recessions since 1980. Four of them began when the PMI^® was below 50 percent, three with it in contractionary territory for at least two months. The mortgage crisis-ignited Great Recession, which began in December 2007 with the PMI^® above 50, was the exception. (ISM’s non-manufacturing index began in 2008.) However, the Report On Business^® composite index numbers typically do not fall off a cliff, they come down over time, so additional months are required to determine if the PMI^® contraction is a trend.

Also, the August NMI^® of 56.4 percent was a 2.7-percentage point gain from the previous month, indicating solid growth in the non-manufacturing sector. Robert A. Dye, Ph.D., chief economist at Comerica Bank in Dallas, wrote in a memo to customers and investors, “The U.S. economy can continue to expand with an ISM (manufacturing) index at about 45, as long as the larger non-manufacturing portion of the economy is healthy. Right now, the services economy is looking relatively healthy.”

The manufacturing sector makes up 12 percent of the U.S. economy, the non-manufacturing sector the remaining 88 percent. Those figures can be used to calculate what Derry calls a real-time “speedometer” for the U.S. economy. As part of the Report On Business^®, ISM correlates — based on decades of historical data — the composite index reading to annualized real gross domestic product (GDP) growth.

For example, the August PMI^® reading of 49.1 percent corresponds to 1.8-percent GDP growth; the NMI^® figure to 2.7-percent GDP growth. Calculating the weighted average of those GDP numbers — with help from the sector percentages above — can provide a current growth snapshot of the U.S. economy. The formula involves (1) multiplying the correlated PMI^® GDP by 12, (2) multiplying the correlated NMI^® GDP by 88, (3) adding those two numbers and (4) dividing by 100. Here’s the math for August:

●(12 x 1.8) + (88 x 2.7)

●21.6 + 237.6 = 259.2

●259.2 ÷ 100 = 2.59 percent GDP

(Last month, the U.S. Commerce Department indicated that annualized GDP growth was 2 percent during the second quarter of 2019.)

“The formula gives a good reading of the U.S. economy at a specific moment,” Derry says. “It’s the closest thing to real-time data available about the economy in the United States. … Businesses can use the data we publish to help them understand where the economy is headed and where certain business conditions might be headed. This gives them valuable insights they can use to to take advantage of opportunities or calibrate their strategies.”