Reporting Focus from the February 2006 Edition of the SGS Newsletter

Once known as the Purchasing Managers Association, the now Institute for Supply Management (ISM) has been publishing a survey of its members’ business conditions on a monthly basis since 1948. What still is commonly known as "the purchasing managers survey" has been a reliable and independent measure of activity in the manufacturing sector for nearly sixty years.

In the late-1990s, a similar survey was started of purchasing managers in the service industry, but aside from indications of inflation and employment pressures, the results appear to have little predictive value against the broad economy. Accordingly, this focus is on the manufacturing survey, though much of what is covered also applies to the non-manufacturing survey.

The purchasing managers survey is constructed from member responses to simple up/down questions on individual business conditions. Each participant gets an equal weighting in the construction of ISM’s diffusion index.

A diffusion index measures the responses to a question of whether orders, for example, are "up," "down" or the "same." The index is constructed taking the percentage of responses that are "up" plus one-half the percentage of the responses that are the "same." Correspondingly, a reading of 50.0% or higher is a positive reading, below 50.0% is taken as a negative.

The traditional components, which are included in the overall index, and for which separate diffusion indices are calculated are: New Orders, Production, Employment, Supplier Deliveries, Inventories, Prices, Backlog of Orders.

Strong new orders, production, employment and prices are all taken as indicators of positive economic activity. Slowing supplier deliveries, falling inventories and a rising backlog of orders, also are taken as positive economic indicators, and the answers are categorized accordingly.

The overall index is a composite of the sub-indices, which, except for prices, get seasonally adjusted by factors determined by the Commerce Department. The seasonals are updated and revised annually.

The purchasing managers survey has been published for as long as the GNP/GDP series, but it has a much longer history of consistent reporting than any government series.

A purchasing managers survey reading below 50.0 used to mean the broad economy was in recession. As methodology changes altered GNP and GDP so as to inhibit the reporting of negative growth, a reading in the purchasing managers survey below 50.0 was redefined to mean the manufacturing sector was in contraction. It is rare for the manufacturing sector to be in recession, without the broad economy moving in tandem or closely behind.

Accordingly, SGS uses the New Orders component of the index, in particular, as a reliable leading indicator of broad economic activity, on both the upside and downside as discussed in the May 2005 SGS.