Market Analysis

Choose Your Own Manufacturing Adventure

US manufacturing was a tale of two surveys in October.

Here are two statements that shouldn't be true simultaneously, but are[i]:

US Manufacturing PMI expands at slowest pace in two years in October.

US Manufacturing PMI picks up to six-month high in October.

There is, of course, a simple explanation for this paradox: There are two US Manufacturing Purchasing Managers' Indexes, colloquially known as PMIs. One rose in October, one fell. Ordinarily, this wouldn't be worth a few hundred words-the two surveys regularly diverge from each other. But given headlines' handwringing over the fact one of these gauges slipped to 50.1, just barely escaping contraction, the time seems ripe for a friendly reminder that no one indicator perfectly captures the entire economy, and investors are best off taking as broad a look as possible.

PMIs are surveys that try to measure activity in a given sector-most commonly, manufacturing or services. Respondents weigh in on growth in output and new business, price movement, hiring, supply chain trends, unfilled orders, inventories and export orders, saying whether each was "better," "same" or "worse" from the prior month. Statisticians compile all the responses into several indexes-one for each survey component-and then aggregate key components into the headline PMI reading. If the PMI exceeds 50, more businesses reported growth than contraction, suggesting the sector overall is growing. If PMI is below 50, it suggests the sector is shrinking.

Both US Manufacturing PMIs topped 50 in October. Markit's PMI rose to 54.1 from September's 53.1, which many interpret as accelerating. But the Institute of Supply Management's PMI ticked down to 50.1 from September's 50.2, which many interpret as barely growing and more evidence the economy has hit a soft patch.[ii]

Which survey is "right"? We're inclined to say both and neither. In general, surveys are a rather flawed way to measure economic activity. They get points for being fast to execute and report, and it's handy to get a read on October's activity two days after month-end. But as you might have gleaned from the above description, PMIs don't even attempt to calculate the magnitude of growth or contraction. Respondents say whether they grew, but not by how much. All you get from PMIs is a rough snapshot of how widespread growth is. So whether 50.1% of firms grew, as ISM's report suggests, or 54.1% grew, as Markit's gauge implies, there is no way to know how much the actual manufacturing sector grew. As for survey quality, Markit pings more firms (600+, vs. only a couple hundred for ISM), but its history is limited: It has surveyed the broad manufacturing sector since 2009 only[iii]. ISM's report goes back to 1948, covering more than 10 full business cycles. ISM weights the headline PMI's five components equally, while Markit allows some variance.[iv] Make of all that what you will. We monitor both, along with a few dozen other metrics[v].

When we analyze PMIs, we tend to look most closely at one component: new orders, which both surveys say sped up nicely in October. Most of the other components are backward-looking, incidental or open to interpretation, giving them little use as an indication of where the economy is heading. But new orders are forward-looking. Today's orders become tomorrow's production. If order books are filling up quickly, it probably means demand is strong and factories will keep humming[vi]. That's a good sign the broader economy is chugging along at a decent clip.

Now, all the preceding 560-ish words detail manufacturing, one small slice of America's huge economy. But they are the only October data available at this point, and interestingly, they allude to the US economy kicking off Q4 on a positive note-in keeping with longstanding trends.

[i] Cue Twilight Zone music and puns about Schrödinger's cat and Dickens. And these.

[ii] ISM says any Manufacturing PMI over 43.1 means the broader economy is expanding. Yes, you read that right. Deep contraction in manufacturing, but the broader economy growing. Now, we wouldn't consider those numbers airtight, but it speaks to manufacturing PMIs' fuzzy, limited nature. It also speaks to the fact manufacturing is a sliver of the US economy, and the service sector accounts for around 75% of total output.

[iii] The survey was born in 2004, but for the first two years it covered electronics goods producers only. In 2007, they added metal goods producers, then they went full-on manufacturing in 2009.

[iv] The five components aggregated into headline PMI are: new orders, output, employment, supplier delivery times and inventories. Markit weights them as follows: new orders at 0.3, output at 0.25, employment at 0.2, delivery times (inverted) at 0.15 and inventories at 0.1.

[v] If you're curious, those would include the yield curve spread, broad money supply, velocity of money, multiple loan growth measures, alternate measures of factory orders and output, service-sector PMIs, trade numbers, retail sales, household spending, wages, disposable income, the Leading Economic Index and everything in it, several freight measures and more-and as many of these as we can round up for everywhere in the world.

[vi] Or whatever the service-sector equivalent of humming factories is. Cash registers going ka-ching, maybe?

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.