What is the ISM Manufacturing Index?
The ISM Manufacturing Index, commonly known as the ISM Manufacturing Purchasing Managers Index (ISM PMI), is a monthly gauge on the level of economic activity in the manufacturing sector in the United States versus the previous month.
The Institute for Supply Management (ISM) publishes the ISM Manufacturing Index monthly.
- The ISM Manufacturing Index provides a gauge on the level of economic activity in the manufacturing sector in the United States.
- A reading above 50 indicates an expansion of U.S. manufacturing, while a reading below 50 indicates a contraction.
- When the ISM Manufacturing Index is greater than expected, it bodes well for the stock market because it indicates healthy economic growth, which translates to higher corporate profits.
Understanding the ISM Manufacturing Index
The ISM Manufacturing Index is published monthly and is an important forward-looking indicator on the U.S. economy. As such, the index is widely followed by economists, analysts, government, business leaders, and supply management professionals. It is based on a survey of purchasing and supply executives (i.e., individuals who are responsible for their firm’s supply chains) in over 400 industrial companies.
Survey participants are asked whether conditions have improved or deteriorated in areas such as commodity prices, backlog orders, new orders, employment, production, inventories, supply deliveries, etc. The raw results are then compiled and seasonally adjusted to form the ISM Manufacturing Index.
The ISM Manufacturing Index ranges from 0 to 100. A reading above 50 indicates an expansion of the manufacturing segment of the U.S. economy, while a reading below 50 points to a contraction.
How Does the ISM Manufacturing Index Impact the Markets?
Through monitoring the ISM Manufacturing Index and comparing it to consensus estimates, investors gain a better understanding of economic trends and conditions. As a result, any deviation from consensus is viewed as a surprise, providing investors with a trading opportunity.
A higher-than-expected reading is bullish for the stock market but bearish for the bond market, and the opposite is true. When the ISM Manufacturing Index is greater than expected, it bodes well for the stock market because it indicates healthy economic growth, which translates to higher corporate profits.
On the contrary, the index expanding greater than expected translates poorly for the bond market because it may provide an indication of potential inflationary pressures.
As an example, the following shows a positive reaction from the S&P 500 Index on a stronger than expected ISM Manufacturing Index for the month of August 2021 (EST: 58.2, ACT: 59.9), which was released on September 1, 2021:
Construction of the ISM Manufacturing Index
Survey respondents are broadly diversified across industries based on the North American Industry Classification System (NAICS). The number of survey respondents within each industry varies depending on that industry’s share of U.S. gross domestic product. Industries include Food, Beverage & Tobacco Products; Textile Mills; Apparel, etc.
To collect data for the index, purchasing and supply executives in the various industries are surveyed on whether certain components at their firm have improved or deteriorated versus the previous month. These components include commodity prices, backlog orders, new orders, employment, production, inventories, imports, new export orders, and supply deliveries.
For each activity, a diffusion index is calculated, as follows:
% Positive Responses + ½ * (% Neutral Responses)
For the ISM Manufacturing Index, the calculation involves an equal-weighted summation of diffusion indexes of five seasonally-adjusted components:
- New Orders
- Supply Deliveries
An example is provided below.
Example of Constructing the ISM Manufacturing Index
The following shows survey participant responses on each component of the ISM Manufacturing Index:
The ISM Manufacturing Index based on the above table would be calculated as follows:
20% * [30% + (½ * 30%)] +
20% * [70% + (½ * 20%)] +
20% * [50% + (½ * 40%)] +
20% * [10% + (½ * 40%)] +
20% * [60% + (½ * 20%]] = 58
As a result, the interpretation of an ISM Manufacturing Index of 58 would be that economic activity in the manufacturing sector in the United States expanded compared to the previous month.
Thank you for reading CFI’s guide to the ISM Manufacturing Index. To keep learning and developing your knowledge, we highly recommend the additional resources below: