PMI – Measuring Manufacturing’s Pulse

July 7, 2022

Understanding market conditions in the manufacturing sector of the U.S. economy is crucial for independent boxmakers large and small across the country. Almost all AICC member paper packaging shipments end up in the factories and plants of U.S. manufacturers to package goods they sell to downstream customers. Therefore, knowing the vital signs of manufacturing activity is central to understanding current and future prospects for paper packaging demand. The Purchasing Managers’ Index (PMI) is the earliest indicator of manufacturing activity, being issued by the Institute for Supply Management (ISM) on the first business day of each month for the prior month’s activity. In use since 1920, the PMI is not only widely used but is considered by many economists to be a very reliable near-term barometer of change in economic activity.

Knowing more about this index and its components can help independent paper packaging converters gauge the manufacturing climate and anticipate changes in the business cycle earlier. The PMI is a composite index for the manufacturing sector of the U.S. economy contained in the ISM’s monthly Report on Business. Each month, survey respondents from the entire manufacturing sector (diversified to reflect each manufacturing industry’s contribution to GDP) are asked to assess their organizations’ performance based on a comparison of the current month to the previous month. They are simply asked if the current level is “better/higher,” “same,” or “worse/lower” than the preceding month. The activities included in the survey are:

New orders from customers
Production level
Employment
Supplier deliveries
Inventories
Customer inventories
Prices
Backlog of orders
New export orders
Imports

The PMI is calculated as the equally weighted average of the first five activities listed above. The results of the survey are contained in the monthly Report on Business, which is released by the ISM at 10 a.m. Eastern time on the first business day of each month. The report, as well as detailed information explaining the survey and its results, can be found at www.ismworld.org.

The survey results are presented in the form of a diffusion index. Diffusion indices have the properties of leading indicators and are convenient summary measures showing the prevailing direction of change. The percent response to the better, same, or worse question is difficult to compare to prior periods. Therefore, the percentages are diffused for this purpose. A diffusion index takes those indicating “better” and half of those indicating “same” and adds the percentages. This effectively measures the bias toward a positive (above 50%) or negative index (below 50%). For example, if the response is 20% better, 70% same, and 10% worse, the diffusion index would be 55% (20% + (0.50 x 70%)). After conversion to a diffusion index, the data for each activity are seasonally adjusted. For the PMI and the indices listed above, a reading above 50% indicates expansion, while a reading below 50% indicates declining activity. The single exception is the supplier deliveries index, where above 50% indicates longer delivery times for input materials and below 50% indicates shorter delivery times. Recently, this index has become important as a measure of change in global supply chain disruption. The chart at left shows the historical PMI trend since 2015.

While the PMI provides an early signal of the peaks and valleys in the manufacturing sector before they appear in government economic data, individual components of the index are useful to predict future growth or contraction. For example, the price index is considered by many to be a good first indication of future inflation or deflation. The new orders and supplier deliveries indices are also leading indicators and offer some insight into the likelihood of future growth or contraction in manufacturing production and, consequently, demand for paper packaging in the next few months. The difference between the new orders diffusion index and the inventory index is a good proxy for future manufacturing production and packaging demand, because both rising new orders and declining inventory levels suggest the need to step up production in the future months. A chart of trends in this indicator is shown in the chart below.

For those who desire a deeper look into the conditions of manufacturing activity, the Report on Business provides additional data for analysis. Each month, commodities reported up or down in price or in short supply are listed. In addition to the aggregated survey percentage responses, each report lists the manufacturing industries that are reporting growth or contraction in each of the manufacturing activities listed above.

In addition to data relating to the component indices, the monthly report contains representative respondents’ commentary regarding market conditions. Average lead times for capital expenditures, production materials, and maintenance, repair, and operating supplies are provided along with percentage of respondents reporting.

With all this data provided monthly on the manufacturing sector by the ISM, it is very tempting to fall into the trap of believing that one month’s change provides by itself a forecast for the future. Assessing and reacting to the trends, not monthly changes alone, provides the most meaningful interpretation of the available data and offers independent paper packaging converters the opportunity to draw independent conclusions regarding the future course of the manufacturing sector and the U.S. economy.