The ISM Non-Manufacturing Survey (also known as the Institute for Supply Management Services index) is a monthly release that shows the growth or decline of the U.S Service industry.
In our “indicator of the week series”, we highlight a specific set of economic data widely seen as a barometer of U.S. corporate health and dissect it so that you can understand and hopefully use it to improve investment returns. Where is this information found? What does the information mean? How can investors use it to help them invest?
The ISM Non-manufacturing survey is created based on the answers of over 400 purchasing and supply managers in the service industry to questions they are given by ISM concerning upcoming business activity, new orders, employment, and supplier deliveries.
The ISM non-manufacturing index is considered to be a “leading indicator” because the results of the survey should give investors a hint about future spending of the companies surveyed. For example, if managers report a huge rise in business activity, investors may be able to assume better earnings out of companies within the industry.
The non-manufacturing survey is released at 10am on the third business day of each month.
So lets delve into the report and see how it can benefit investors.
The latest survey can be found on ISM’s website, here: http://www.ism.ws/ISMReport/?navItemNumber=22306
Below we are showing the April 3rd 2013 release.
The release starts out with the “headline number”. All the answers from the 400 managers regarding inventory, employment, spending, etc. all come together to generate this number.
54.4% was the reading for this month. This is the number you will see on the news headline, and is the first number that investors are looking for. So what does it tell you?
ISM’s description for the number is:
“The NMI™ (Non-Manufacturing Index) is a composite index based on the diffusion indexes for four of the indicators with equal weights: Business Activity (seasonally adjusted), New Orders (seasonally adjusted), Employment (seasonally adjusted) and Supplier Deliveries. Diffusion indexes have the properties of leading indicators and are convenient summary measures showing the prevailing direction of change and the scope of change.”
Basically, what you need to know is that a number greater than 50% tells of growth in the U.S. service sector, a number less than 50% shows a shrinking service sector and 50% on the dot means no change.
The reading here of 54.4% means modest growth for the industry. However February’s number was higher at 56%. Although March’s number indicated growth, it indicated that growth was slower than just a month ago (54.4 is less than 56 – which shows slower growth, but both numbers are over 50 – indicating an increase in economic activity in the service sector.)
At 10am on the third business day of each month, you will see this number displayed on the front page of nearly any financial news website:
But making any investment based solely on that headline number is useless and nothing but speculation. The real data which you should use comes from deeper in the report.
Looking further down into the report:
After the headline number, the report shows 3 main components that make up the 54.4 headline number seen initially.
Business Activity index, which is sales the business are seeing.
New Orders Index, which measures new business of the companies.
And the Employment Index, which indicates if companies are hiring or firing workers.
Each of these numbers are based on the same index as the headline number. Greater than 50% means growth, less than 50% means contraction.
Then ISM provides some discussion on the numbers, comparing each result to previous readings and various other facts about the industry that are presented in more depth later.
Next the report touches on industry specific data, shown at the bottom in the above picture. Here the ISM reports industries that are seeing growth, and those which are not. Investors can use this information as initial research for an investment decision. Investment options may include buying specific sector ETFs of growing industries, or maybe specific stocks in a growing industry. Or the information may cause you to decide against a specific investment in an industry if the industry is falling on hard times.
Next the report gets into more specifics on additional topics discussed in the survey:
Here, investors can get a glimpse on what companies are seeing change in their business. Prices, orders, inventory, etc etc.
Lastly, the report shows specifics on commodities that are changing in price:
Once again, potentially useful for investment ideas for those willing to do some homework. A rising price of a commodity can be good or bad for a company based on its business model. For a company in the freight shipping business (say a railroad or trucking company), this report may be a good sign as it may signal increased margins or increased demand (The picture above shows an increase in freight shipping costs, and a decline in diesel fuel – both would be positives for the freight industry). For a company that has to buy and then install roofing shingles for a customer, rising prices may mean shrinking margins if the increase in cost cannot be passed onto the consumer.
The report concludes with some comparison of historical data, something which we will look at in more detail below.
So that’s the report at a glance. A lot of information packed into a couple of pages of a press release, but certainly important to know and understand.
Knowledge is important, but can these numbers actually help you invest?
The St. Louis Federal Reserve makes comparing some of the ISM data to stock market returns easy with their “FRED” research tools.
Comparing the top three components of the ISM index to the S&P 500 returns:
Business Activity Index (in blue), compared to the S&P 500 index (in red):
New Orders Index, compared to the S&P 500:
Employment Index, compared to the S&P 500:
I could probably get a million different answers on what the charts above show (or what they don’t).
If anything I think the charts above should cause investors to be more cautious if they see large divergences in the trends of the indices and the stock market. I am looking at specifically around 2007 when all ISM data was signaling a slowdown, but stocks skyrocketed…only to fall back to earth a year later.
I have recently picked up the book The Wall Street Journal Guide to the 50 Economic Indicators That Really Matterwhere this indicator is featured. What did they have to say?
“Karl (chief U.S. economist at Swiss Re) says he likes to look at the “new orders” figure as it is “more forward looking” than the headline figure….when it is increasing, now is the time to purchase riskier assets like stocks and sell old, recession-proof standbys like government bonds”
Last Words
As an investor, the ISM non-manufacturing survey is just one potential tool in your toolbox. It should also be noted that the results from this survey are relatively volatile, and are often revised in the months after the initial report. So never out too much importance on one single number.
The data from this indicator alone should never be solely the reason for an investment. Any investment decisions should be based on extensive research and the advice of a financial planner.
