Stocks are shares of ownership in publicly traded businesses that operate and constitute investments in a portion of the global economy. At the same time, understanding economic trends gleaned from these businesses can be vital in helping to achieve your long-term investing goals. Fisher Investments reviews one potentially useful indicator—Purchasing Managers’ Indexes, or PMIs. These gauges have some key nuances we think investors benefit from understanding.
PMIs are monthly surveys sent to hundreds of business owners asking how items including output, new orders, inventories, employment and input costs evolved from the previous month. They aim to measure how widespread economic growth is within various sectors—most commonly manufacturing and services.
The US’s Institute for Supply Management pioneered the practice in the 1930s with its manufacturing PMI. A non-manufacturing version followed later in the 20th century. Others have taken up the practice and PMIs from various research organizations, financial firms, universities and government entities now span much of the world, covering both manufacturing and services.
PMIs have a headline reading which represents the sector’s overall health. It parses together an array of components. Generally, headline readings over 50 indicate expansion, while below 50 signals contraction. Because PMIs are the first major data series to come out for a given month, they are among the timeliest look at whether growth continued—and the financial press pays them heavy attention as a result. But they aren’t foolproof, as surveys are generally more malleable than output measures.
Fisher Investments reviews PMI components to help inform our views of current trends. PMIs aren’t predictive, as most of their components are coincident (output, prices, inventories, supplier delivery times, etc.) or lagging. The employment component gets a lot of attention, but it is a trailing indicator as growth creates jobs—not the other way around.
New orders (and, to a lesser extent, order backlogs), however, are more forward-looking. Today’s orders become tomorrow’s production. Hence, a sustained decline in new orders often precedes broader weakness. The less forward-looking components can also illuminate trends. Lately, reports on order backlogs and supplier delivery times have been a good way to assess supply chain difficulties. Imports can hint at whether trade spats or tariffs are reordering commerce. Weighing inventories against orders can help show whether supply is at risk of overwhelming demand. Input prices can give an early look at whether commodity price swings are affecting businesses (and, potentially, consumer prices).
While PMIs are useful, it is worth remembering that economic data’s interpretative value is limited. For PMIs, it is vital to remember they measure the breadth, not the magnitude, of economic growth. A PMI tells you the loose percentage of businesses that reported growth. But it won’t reveal how much businesses overall grew (or contracted). Therefore, it is possible for a contractionary PMI reading to coincide with actual economic growth if the companies that grew expanded more than the contracting companies shrank. Similarly, an expansionary PMI may obscure an actual reduction in activity if the declines at contracting companies were deep enough to offset growth elsewhere.
Knowing this can help you put headline reactions to small PMI changes in context. When Fisher Investments reviews coverage, we often see great fanfare if a PMI rises, say, from 55 to 56. Looks nice, but it is largely meaningless. It basically means about 56% of businesses grew, versus 55% the previous month. But if all those businesses encountered very slow growth, then the output data that come out later in the month could show growth weakened. Similarly, a PMI that drops from something like 53 to 52 often generates much handwringing. But it doesn’t mean economic growth actually slowed. In our view, small changes in either direction are functionally meaningless.
When Fisher Investments reviews PMIs, we think it is most helpful to focus on broad trends. A long stretch of PMIs well over 50 is generally inconsistent with recession, especially if new orders remain expansive. Similarly, PMIs will likely spend significant time well under 50 during a recession. So if recession fears are everywhere but PMIs are nicely over 50, that can tell you something. So can a wave of contractionary PMIs paired with economic optimism. It implies that sentiment may be disconnected from reality, an actionable scenario for investors, in our view.
No economic indicator is perfect, including PMIs. Their main benefits are their timeliness and breadth. But surveys aren’t precise, and Fisher Investments thinks it is best to look at PMIs and output data (e.g., industrial production, retail sales, etc.) in concert when determining whether economic reality is better or worse than expectations.
Investing in securities involves a risk of loss. Past performance is never a guarantee of future returns. Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations. The foregoing constitutes the general views of Fisher Investments and should not be regarded as personalized investment advice or a reflection of the performance of Fisher Investments or its clients. Nothing herein is intended to be a recommendation or a forecast of market conditions. Rather it is intended to illustrate a point. Current and future markets may differ significantly from those illustrated herein. Not all past forecasts were, nor future forecasts may be, as accurate as those predicted herein.