How Is It Computed?
The ISM’s manufacturing survey has an interesting history. Its origin can be traced to Herbert Hoover. Faced with a collapsing U.S. economy during the Great Depression, President Hoover was frustrated by the lack of current data on the health of American manufacturers. He approached the ISM, then known as the National Association of Purchasing Agents, and urged them to develop a survey that would provide up-to-date information on the health of this important part of the economy. The group complied, and the survey began in 1931. It has been around ever since, except for a brief four-year interruption during World War II.
Nowadays, the ISM mails out questionnaires every month to about 400 member companies around the country, representing 20 different industries. Corporate purchasing managers are asked to assess whether activity is rising, falling, or unchanged in the following fields:
• New orders: Purchasing agents ask their salespeople about new orders received.
• Production: Manufacturing output.
• Employment: Hiring in the company.
• Supplier deliveries (or vendor performance): Speed of delivery from suppliers.
• Inventories: The rate of liquidating manufacturers’ inventories.
• Customers’ inventories: Agents guess the inventory levels of their customers.
• Commodity prices: Prices paid by manufacturers for supplies.
• Backlog of orders: Orders not yet filled.
• New export orders: Rate of new orders from other countries.
• Imports: Material that agents purchased from other countries.
(Seasonal adjustment factors are applied only on new orders, production, employment, supplier deliveries, inventories, export orders, and imports.)
The Purchasing Managers Index (PMI) itself is a compilation based on the responses to the first five queries in the preceding list. They are weighted equitably to compute the index: new orders (20%), manufacturing production (20%), employment (20%), supplier deliveries (20%), and inventories (20%). The bottom five entries provide additional coverage on how manufacturing is performing. The PMI is calculated as a so-called diffusion index, which by definition measures the degree to which a change in something is dispersed or “diffused” in a particular group. It does not show actual levels of production. As the responses from members come in, the ISM takes the percentage of those who reported activity being higher in each component and adds that to half the percentage of those who reported seeing no changes. The result is then adjusted for seasonal factors. If the result is an index number above 50, it means the manufacturing sector is growing. Below 50 means it’s contracting. An index of 50 represents no change in activity.
Here are two examples: Let’s say 100% of those surveyed reported no change in manufacturing production. To come up with the index, take half the percentage of those who said orders were unchanged (which gives you 50%) and add it to the percentage of agents who saw higher activity (no one did, so it’s 0%). If the outcome comes to a seasonally adjusted index of 50, it means that purchasing managers have seen no discernible change in manufacturing output from one month to the next.
In the second example, we’ll assume that 30% of the agents reported higher activity, and 50% noticed no change in business. The diffusion index in this case comes to 55% (30 plus half of 50 plus assume a seasonally adjusted factor of 1.0), which is a sign that manufacturing output is expanding.”
Excerpt From: Bernard Baumohl. “The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends and Investment Opportunities, 3/e.” iBooks. https://itunes.apple.com/us/book/secrets-economic-indicators-hidden-clues-to-future/id547218470?mt=11