ISM Manufacturing Index Advances, But How Strong Is It Really?

by: Robert Brusca

The ISM Manufacturing survey is upbeat in January as its index has risen to 54.1 from 53.1, a gain of one point. The employment reading stepped back by one-half of one-point, to stand at 54.3 in January down from 54.8 in December.

The ISM MFG index has nine main components and three metrics on lead-times. The ISM framework uses a statistic that implies expansion for the index or a component when the month's observation is above 50, contraction when it is below 50 and no change at a value of 50. The index and component readings range over a 100 point span from zero to 100. However, the various ISM components have different averages and different variabilities and for those reasons, discerning what the various categories tell us each month is not a straight forward process.

The ISM index itself is a weighted average of its components; since 1994, it has averaged 51.9. Prices, production and new orders have the highest average over this period at 58.1, 55 and 54.9 respectively. Order back logs and employment at 48.3 and 48.4 respectively have the lowest average readings. While all ISM components have the same theoretical range of 100 points, the ISM itself has ranged over only 28.3 points since late 1994. Prices have the greatest range at 73.5 points (with new orders second at a range of 48.1 points). The supplier delivery and inventory metrics have the most compressed ranges for this period, varying over about 25 points (or only one-quarter of their potential). The size of the range is also a good proxy for the overall variability of each category.

To better comprehend what each component reading means we assess each in three ways: We look at each as a percentage of its mean, as a percentile standing in its high/low range, and as a percentile level in its ordered queue of values. This process gives us more information on each category. The overall ISM stands at 104% of its average. Is also stands at the 74th percentile of its high-low range. And it stands at the 64.8th percentile of its ordered queue. That means that it is lower than this 64% of the time and higher only 36% of the time. The high-low range tells us that it is relatively high in its high-Low range, which means there is relatively less space between this index level and the range top compared to the number of observations between the current value and the highest. The two metrics give us insight as to the density of the readings above and below the current value. One tells us about how much higher the highest reading is the other how often the current reading gets higher than it is. Each are useful and different pieces of information.

The table puts the MFG PMI readings in some perspective. We can see each component as a percentage of its average value as a percentile of its high/low range or as a percentile standing in its ordered queue of values. Despite the setback in the employment metric this month, the employment metric is strong among all the component readings, it is the highest as percentage of its average, it is the second-strongest queue reading and it is the strongest in its high/low range percentile standing. ISM production backed off this month with that reading falling from 58.9 in December to 55.7 in January, leaving that component barely above its mean value and below its median at a 49% queue standing (the median is at 50% of the queue). Still, new orders are strong and backlogs, an important reading for future job growth, each are strong. But the inventory reading is high and that may be one thing that is weighing down on production. Delivery speeds show plenty of slack in all its metrics, with consistently low readings. Export orders that rose this month are firm, while the import orders index that fell-off is generally just above its average and queue mid-points.

The data on lead times show that production lead times are stretched out slightly for all components. Increasing lead times suggest planning farther ahead and are good signals for improved growth expectations. Despite the turn down in production this month, the lead times for production materials are up to 57 days; that is a 98th percentile standing in its queue. Capital expenditures whose lead times were up strongly in January are still below their median value and at the 48th percentile of their queue. Still, this may be more of a legacy value as the component has been moving higher steadily over the past year. Maintenance and repair lead times are also strong, standing in the 92nd percentile of their queue, higher only 8% of the time.

On balance, the ISM is still relatively upbeat. The labor metric has backtracked, but its standing is still at an impressively high level. Of course, the average for the MFG sector's monthly changes in employment (back to late 1994) is -22K per month, so we have to bear that in mind when we assess MFG. MFG has been a steady job-losing sector in the U.S., with recession job losses usually never ever making up the job losses in full. Even firm ISM job readings may not point to job growth.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.