Key learning points
- The ISM Manufacturing Index is a leading indicator of the health of the manufacturing industry.
- Current signs indicate that inflation is slowly starting to decline.
- Investors should pay attention to key economic indicators to gauge inflation and future interest rates, and adjust their portfolios accordingly.
Many investors are aware of reports that help the Federal Reserve determine interest rates. The most prominent is the US Consumer Price Index (CPI), but not many investors know that additional reports are available. These reports don’t get much coverage, but they’re just as important.
The ISM Manufacturing Index is one such report. It offers a wealth of knowledge when it comes to the health of the US manufacturing industry. Let’s take a look at who is generating this report, as well as the data it contains and what that means for inflation and the economy in general.
What is the Institute of Supply Management?
The Institute for Supply Management is the world’s largest non-profit professional supply management organization. Founded in 1915, it certifies, trains and develops leaders for the supply chain industry. It also surveys purchasing managers and publishes the ISM Manufacturing Index.
What is the ISM Manufacturing Index?
The ISM Manufacturing Index is a leading economic indicator of the level of economic activity in the manufacturing sector in the United States. This means that the results of this report indicate or predict what will happen in the economy in the future.
The stock market is another leading economic indicator. The market may recover if investors expect positive economic times. On the other hand, it could sink into a bear market if they expect the economy to sour in the near term.
There are also lagging indicators, which show trends in retrospect. These are reports that come out after the boom or bust cycle of the economy has started. For example, the National Bureau of Economic Research will formally declare that the US economy is in recession a few months after the economy enters recession.
Overall, there are a handful of leading and lagging indicators that collectively give analysts a more complete picture of the health of the economy.
Are we moving in the right direction?
The latest collection of data from the August 2022 PMI is a mixed bag. On the upside, the paid price component of the ISM Manufacturing Index is falling sharply, which is a good sign. It points to a stronger balance between supply and demand, which benefits consumers by slowing down price increases.
During the inflation peaks of the 1970s and 1980s, a decline in prices paid was a leading indicator of lower inflation. If the same is true today, we could see an easing of the inflation front in the coming months.
The negative side of the report’s findings is that factory growth remains sluggish and production has slowed. A dark cloud still hangs over the outlook for the economy, and experts continue to debate whether the US will slip into recession. While consumers remain strong, companies are cautious.
US gas prices have fallen to an average of $3,677/gallon, down more than 25% from their record highs in mid-June; prices are at their lowest level in six months. This is also a good sign for both consumers and the economy.
As driving becomes more affordable, people can travel more and have more money to spend on things other than gasoline. However, the question is whether the low prices will hold. While the fall season brings a cheaper gas mixture to produce, there will be colder weather soon enough to cope.
Global container freight rates have hit 16-month lows, down 52% from their peak. This is still four times higher than the pre-pandemic level, but it is moving in the right direction. For many months, demand outstripped supply as lockdowns and supply chain problems caused delays. Now that the supply of goods and the demand to ship them have become equal, prices have fallen.
The supply chain still has a long way to go to fully meet demand, but signs are pointing in the right direction.
What indicators are investors looking at?
What indicators should you, as an investor, look for clues to the health of the economy? There are a few key indicators to look at, both leading indicators and lagging indicators.
Pay attention to the stock market, retail sales and manufacturing activities for leading indicators. While there are others, these three will give you a good foundation for how the economy is doing.
For lagging indicators, look at the US consumer price index, income and wages, and the unemployment rate. Again, there are others, but these will give you the clearest picture.
Understanding the data that helps the Federal Reserve form an opinion about the health of the economy is essential for investors. While not foolproof, looking at leading indicators can help you review your investment plan and make the necessary changes.
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