Before I get deep into the topic of this post, I think it is important to share a couple of definitions from About.com’s “A Beginner’s Guide To Economic Indicators” (or any Economics 101 course in a university, or even a good high school)…
Economic Indicator: “Any economic statistic…which indicate(s) how well the economy is doing and how well the economy is going to do in the future.”
Leading Indicator: “[Economic] indicators which change before the economy changes.”
Lagging (or Lagged) Indicator: “[An] economic indicator…that does not change direction until a few quarters after the economy does.”
One economic indicator that people look at is the PMI contained in the ISM Report on Business. Now, ISM has always referred to the PMI as a leading indicator.
But is it?
Well, let’s see. As I covered right here on this blog, when the United States’ Gross Domestic Product – the true measure of the size of the economy – contracted after years of growth in the third quarter of last year, ISM’s index indicated the opposite. The economy was growing according to ISM.
ISM’s PMI eventually indicated that the economy was contracting. So, at best, the PMI appears to be a lagging indicator.
Some recent posts on Supply Excellence have unintentionally amplified ISM’s out-of-sync-ness by examining sub-indices that comprise the PMI – which covers the manufacturing sector but still is used by ISM to make a questionable correlation to the overall economy – and the NMI, which covers the service sector. Two days ago, SE blogger Pat Furey wrote that while the most recent employment sub-index for both the PMI and NMI were “well below the benchmark for expansion…the ISM Employment Index tends to lead the data from the Bureau of Labor Statistics, so don’t be surprised if the numbers above hit 50 before the broader unemployment data starts to decline.”
Actually, just today, the US government reported that unemployment declined in July compared to June. So, while ISM says unemployment is rising, albeit at a slower pace, the real numbers prove otherwise. ISM’s Employment Index may indeed show growth in the future but, when it does, it will be on a lagging basis, not a leading one.
One more point I’ll make here…ISM’s indices should never be displayed graphically. It only serves to confuse people.
Here’s why…ISM’s indexes are set up goofily where a number below 50 indicates contraction from the previous month and a number above 50 indicates expansion from the previous month. Except of course, when the PMI is above 41.2, which means that the manufacturing sector’s contraction is small enough to indicate growth in the overall economy.
So imagine a situation where you have the following index values:
Month 1 – 42.8
Month 2 – 44.8
Month 3 – 48.9
If these values were graphed, you’d think things are improving month to month. You’d have an upward trending line. What it actually means is that each month is worse than the previous month because all values are below 50.
With regard to an earlier Supply Excellence post on ISM’s New Orders Index, I thought that there also needs to be clarification on what “bottoming out” means in the economic sense. Bottoming out means that the economy (or a subset thereof) has ceased to decline and is at the point to resume growth. For the way that ISM structures its indices, this means that the point at which 50 is reached after a period with values under 50 is where the bottom is reached (assuming the trend of improvement continues afterwards).
In that post, Mr. Furey analyzed a graphical representation of the ISM New Orders Index and wrote that “As one can see from the graph above, new orders for both goods and services began a steady decline last September. However, the manufacturing sector bottomed out in December at an all-time record low of 23.1.” I don’t like to be a stickler over words – especially because the quality of blogging at Supply Excellence is so darn good – but because the index value has not passed 50 since December, the values mean that July was worse than December. The bottoming out hasn’t happened yet, according to the ISM numbers.
I think that this confusion makes it clear that ISM’s reporting is poorly structured. In my mind, there is no excuse for that. There are plenty of well-structured economic indicators that they could use as templates. The economic indicators published by the Conference Board come to mind in this regard.
If you’re interesting in reading more about how ISM’s economic indicators are confusing at best, misleading at worst, here are some more posts that you may want to check out:
Caveat Emptor: Economic Indices Could Be Misleading You (November 30, 2006)
ISM’s PMI is BS (February 6, 2008)
The ISM Index Gets More Amusing By The Second (March 4, 2008)
Another ISM Index Contradiction (March 5, 2008)
Today’s GDP Release Leaves ISM With Egg On Its Face (October 30, 2008)
To Your Career,
Charles Dominick, SPSM
President & Chief Procurement Officer
Next Level Purchasing, Inc.
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