What is PMI Index?
PMI Index Explained
The PMI index (Purchasing Managers' Index) is a leading economic indicator for the manufacturing, service and hospital industries. It is a summary of many purchasing managers' opinions on whether their businesses are growing, shrinking or staying the same. It is comprised of multiple time series (also known as diffusion index) to provide an accurate measure of economic health.[1]
The PMI index enables central authorities, investors, executives and traders to quickly gauge whether an economy is inflationary, deflationary or stagnating, and make better-informed decisions.
What is a Purchasing Manager? A purchasing manager, also known a procurement manager, is an individual who purchases goods and services for businesses purposes. For example, a purchasing manager may purchase raw materials to produce finished goods for sale.[2]
Definition and Examples of PMI Index
The PMI Index is a summary of Purchasing Manager's opinions on how their businesses are performing. It can provide economists, investors and policymakers with a clearer view of the overall health of the manufacturing, services and hospital sectors.
The PMI is produced by the Institute of Supply Management in the U.S. and IHS Markit Group for the rest of the world. Examples of the U.S. PMI Index include:
ISM Manufacturing Purchasing Managers' Index - reports the performance of the manufacturing sector
ISM Services Purchasing Managers' Index - reports the performance of the services sector
and ISM Hospital Purchasing Managers' Index - reports the performance of the hospital sector
These reports are published on the first and third business day of each month respectively, with hospital reports on the fifth business day of each month.
Expert Tip: PMI is a leading indicator used by traders to quickly decide which sectors are growing, and which are contracting in specific countries.[3]
Each PMI represents separate sectors of an economy, and when combined provide a holistic overview of an industry.
Alternate name: Purchasing Managers' Index
Acronyms: PMI, ISM PMI
How does PMI Index Work?
The formula for the PMI Index is based on a monthly survey conducted to over 400 companies in 19 industries which are dynamically weighted depending upon their contribution to the United States GDP.
The PMI index is formulated by getting responses from purchasing managers' positive, neutral or negative outlooks on:
New Orders
Production
Employment
Supplier Deliveries
Inventories
Customer's Inventories
Prices
Backlog of Order
New Export Orders
and Imports
These are then combined, generating a numerical value that benchmarks the industry between 0 to 100.
How Do You Calculate PMI Index?
To calculate the PMI Index, the responses from the Purchasing Managers’ are segregated into groups based upon whether they’re reporting an improvement, no-change, or decline (deterioration) in their industry. Once separated, the percentage of respondents in each category is calculated, and then weighted using this PMI index formula:
PMI = (P1*1) + (P2*0.5) + (P3*0), where:
P1 = Percentage of survey respondents who reported an improvement
P2 = Percentage of survey respondents who reported no-change
P3 = Percentage of survey respondents who reported deterioration
Examples of PMI Index Formula
If 50% of the PMI index respondents reported an improvement, 25% with no change, and 25% with deterioration, then:
P1 = 50% of respondents
P2 = 25% of respondents
P3 = 25% of respondents
Substituting P1, P2, and P3 into the PMI index Formula:
PMI Index = (50 * 1) + (25 * 0.5) + (25 * 0) = 50 + 12.5 + 0 = 62.5%
When the majority of respondents (50%) reported an improvement, the PMI index equalled 62.5%. If the index reading was 100%, this suggests all respondents reported improvement, whereas if it was 0%, all respondents reported a deterioration:
PMI Index > 50, indicates that the majority of respondents report an improvement
PMI Index = 50, indicates that the majority of respondents report no change
PMI Index < 50, indicates that the majority of respondents report deterioration
A PMI Index of 50, is considered as the neutral point, with no changes in respondents' opinions, with PMI index values above 50 implying improvement, and below 50 a decline. The larger the distance from the 50 value, either positive or negative, the larger the magnitude of the improvement or decline, respectively.
Below is a quick example of what the ISM Manufacturing Purchasing Managers’ Index looked like in May 2021 using the above surveys as contributing factors:
The large percentage number at the top (61.2%) suggests that the majority of the respondents in May 2021 reported improvements, overall indicating high growth in the U.S. economy.
The ISM PMI Index then delves deeper into how this 61.2% value was achieved including factors such as typical business conditions, future outlooks, and whether they're good or bad for the manufacturing sector.
What is manufacturing PMI? Manufacturing PMI is a composite index that measures the overall performance of manufacturing businesses in a particular country by surveying manufacturing firms. It is considered to be a key indicator for the state of the U.S. economy.
What is a Good PMI Index Value?
A PMI index above 50 indicates overall growth across the industry. Conversely, a PMI index below 50 indicates a contraction in the industry. It’s also worth mentioning that the change in the PMI index value from the previous month's value, is important to consider - it tells investors whether or not growth is accelerating or decelerating impending a reversal to a contractionary condition.
A deceleration in growth is a sign of an industry overheating, and a deceleration in decline is a sign that economic policies need loosening. Commonly referred to as peaks (tops) and toughs (bottoms) of the PMI index values.
How do Investors Use PMI Index?
Investors and traders alike can use the ISM report in many ways. The overall percentage at the top of the PMI index is used by forex traders as the leading currency strength factor, whilst stock investors would find greater benefit from the qualitative statements within the PMI Index report.[4]
For example, if a forex trader notices the PMI Index is above 50% and is increasing, this is a sign that the U.S. economy is experiencing price increases (inflation), which generally weakens the value of the U.S. dollar. This may indicate to the investor to sell or 'go short' on the U.S. dollar currency. On the flip side, if the PMI index is below 50%, and is decreasing, this indicates overall the U.S. may be experiencing deflationary measures, and encourage investors to sell or 'go short' on the U.S. dollar.
Below is a quick summary table of how currency investors may use different PMI index values to make better-informed decisions:
If the PMI index is more than 50, this is an inflationary signal (prices of goods and services rising overall), which reduces the purchasing power of the domestic currency. This encourages forex traders to seek a potential short position (sell) to attain a different currency whose purchasing power may be strengthening, providing a better return. The opposite holds true if the PMI index is below 50.
If the PMI index is more than 50, but it peaks, this is a sign of imminent deflationary conditions - encouraging central authorities to potentially hike interest rates, or tighten their policies to curb the drastic increases in the price of goods and services. The aim is to reduce price overall, which in turn increases the purchasing power of the domestic currency, which may lead forex traders to go ‘long’ or buy it. The opposite holds true if the PMI index is below 50, but bottoms out.
Key Points
PMI Index is a leading economic indicator that gauges Purchasing Managers’ opinions in a particular industry.
Investors use the PMI index to gauge inflationary or deflationary market conditions and make better-informed investment decisions.
The PMI Index is produced by the Institute for Supply Management in the U.S. and IHS Markit for the rest of the world.
Article Sources
[1] Getz, Patricia M. and Mark Ulmer. "Diffusion indexes: an economic barometer," Accessed July 2, 2021.
[2] Prospects. "Procurement Manager," Accessed July 2, 2021.
[3] The Conference Board. "Global Business Cycle Indicators," Accessed July 02, 2021.
[4] Evan F. Koenig. "Using the purchasing managers' index to assess the economy's strength and the likely direction of monetary policy," Federal Reserve Bank of Dallas. Accessed July 01, 2021.
