February ISM Index

Updated 09-Mar-10 19:33 ET

About this release

Highlights

Growth in the manufacturing sector slowed according to the latest ISM report. The ISM index fell from 58.4 in January to 56.5 in February.
The consensus expected the index to fall, but only to 58.0.

Key Factors

Production and new orders slowed significantly in February as the production index fell from 66.2 to 58.4 while the new orders index declined from 65.9 to 59.5.
Inventories inched closer to the 50.0 threshold as the index rose to 47.3 from 46.5. However, customer inventories are still declining at a rapid pace as the index is still well below 50 at 37.0.
Employment is gaining strength as the index remained above 50.0 for the third consecutive month. The index increased from 53.3 to 56.1 and is now at its highest level since January 2005.

Big Picture

This is a highly overrated index. It is merely a survey of purchasing managers. It is a diffusion index, which means that it reflects the number of people saying conditions are better compared to the number saying conditions are worse. It does not weight for size of the firm, or for the degree of better/worse. It can therefore underestimate conditions if there is a great deal of strength in a few firms. The data have thus not been either a good forecasting tool or a good read on current conditions during this business cycle. It must be recognized that the index is not hard data of any kind, but simply a survey that provides broad indications of trends.

Category	FEB	JAN	DEC	NOV	OCT
Total Index	56.5	58.4	54.9	53.7	55.2
Orders	59.5	65.9	64.8	61.5	58.3
Production	58.4	66.2	59.7	60.2	62.2
Employment	56.1	53.3	50.2	49.6	51.8
Deliveries	61.1	60.1	56.8	55.7	56.3
Inventories	47.3	46.5	43.0	41.4	47.3
Export Orders	56.5	58.5	50.2	56.0	55.5
Prices paid (not seas adj)	67.0	70.0	61.5	55.0	65.0

Release Details

ISM: Institute for Supply Management

formerly NAPM: National Association of Purchasing Managers

Importance (A-F): This release merits an A-.
Source: Institute for Supply Management
Release Time: 10:00 ET on the first business day of the month for the prior month.
Raw Data Available At: http://www.ism.ws/.

In Brief

The ISM report is a national survey of purchasing managers which covers such indicators as new orders, production, employment, inventories, delivery times, prices, export orders, and import orders. Diffusion indexes are produced for each of these categories, with a reading over 50% indicating expansion relative to the prior month, and a sub-50% reading indicating contraction.

The total index is calculated based on a weighted average of the following five sub-indexes, with weights in parentheses: new orders (30%), production (25%), employment (20%), deliveries (15%), and inventories (10%).

The ISM is one of the first comprehensive economic releases of the month, typically preceding the employment report. Though it covers only the manufacturing sector, it can often provide accurate hints regarding the tone of subsequent releases. During periods of inflation concerns, the prices paid and vendor deliveries indexes often determine the bond market's reaction to the report.

In Depth

The Institute for Supply Management's monthly Report on Business is probably the most widely watched economic indicator produced by the private sector. There are two key reasons for the ISM's prominence. First, its longevity - the report was first produced in 1931, and after a break during World War II, it has produced continuously since 1948. Second , its leading quality - the ISM has been one of the better predictors of the business cycle over the years.

Who and What It Surveys

The ISM index is the result of a monthly survey of over 400 companies in 20 industries throughout the 50 states. The survey queries respondents on a number of monthly indicators, including orders, production, employment, inventories, delivery times, prices paid, export orders, and import orders. Respondents are asked to characterize each indicator as higher, lower, or unchanged for the month (or faster/slower in the case of delivery times). They are not asked for specific numbers - only a thumbs up or down.

Presenting the Numbers

Based on these responses, the ISM calculates diffusion indexes for each of the components. These diffusion indexes are calculated by adding half of the percentage of respondents answering "unchanged" to the percentage answering "higher" (or "slower" for deliveries). These diffusion indexes do not yield estimates of specific magnitudes of strength or weakness, but the more respondents who are indicating trends in the same direction - the better the chance that the magnitude of that move is larger.

A diffusion index of 50% is the theoretical breakeven mark - with readings above indicating strength and below indicating weakness. The ISM only provides the raw data - the Department of Commerce produces the seasonal factors which are used to provide more meaningful, seasonally adjusted indexes.

The total index is not the result of a separate question regarding general business conditions (as is the case with the Philadelphia Fed index). Instead, the index is calculated using the weighted sum of five of the subindexes. Orders account for 30% of the total; production - 25%; employment - 20%; deliveries - 15%; inventories - 10%. Prices, export orders, and import orders are not part of the total index.

Breakevens in Theory and Practice

Though 50% is the breakeven mark in theory, different readings have proved to be breakeven in practice. For new orders, 50.3% is the level consistent with breakeven readings in factory orders. For production, 49.4% has been the breakeven mark in theory and practice. For employment, 47.5% has been consistent with a steady level of manufacturing employment. For inventories, 41.3% has been consistent with steady business inventory readings. And finally, the 42.7% mark on the total index marks the point below which the overall economy is believed to be in recession. Between 42.7-50%, the manufacturing sector may be in decline, but the total economy is only seeing slower growth.

No Services

This observation highlights the important element which is missing from the ISM index - the service sector. With the manufacturing sector making up an ever-shrinking percentage of the total economy - the ISM might seem to be an indicator in decline. Not so, however - the manufacturing sector, while shrinking in relative terms, still tends to lead the total economy into and out of recessions. The ISM therefore remains a closely watched indicator despite its manufacturing focus.

A Proven Performer

The ISM's leading quality has been proven over time. Its bottom during a recession has preceded the turning point for the business cycle by an average of four months, and its worst performance in leading the turning point was on two occasions when the ISM trough occurred in the same month as the business cycle trough. The ISM index is released on the first business day of each at 10:00 ET, with data for the prior calendar month.

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