Institute for Supply Management, ISMManufacturing Index

(Measure of Manufacturing Activity)

Web: http://www.ism.ws/ISMReport/index.cfmNo monthly revisions,…but reassessments of seasonal adjustment factors in January

ISM is a private, Tempe, Arizona based group that represents corporate purchasing managers – procure production materials and supplies to make products – in the goods-producing industry – highly sensitive to the ebb and flow overall economic activity.

Survey results come out the first business day of every month (very timely)ISM surveys 400 companies, representing 20 industries, to assess if activity is rising, falling or unchanged in the following fields:New Orders (30%) - by purchasing agentsProduction (25%) - manufacturing outputEmployment (20%) – hiring by the companySupplier deliveries/Vendor performance (15%) – speed of supplier deliveryInventories (10%) – the rate of liquidating manufacturers’ inventories

Purchasing Managers Index (PMI) is a compilation of the 5 components listed above weighted by the given percentages. The PMI is a diffusion index, showing changes in month to month activity, but not actual levels of production.

Component number = % reporting rising + ½ % reporting no change

PMI is an effective gauge of business cycle turning pointsIf PMI > 60 for a sustainable period with the economy operating above potential => Fed raising interest rates If PMI > 50 => expanding manufacturing sector, with every additional full index point adding 0.3 percentage points of economic growth over next 12

months. If PMI = 50 => no change in manufacturing activity, with Y/Y = 2.5%If 43 < PMI < 50 => contracting manufacturing sector, but economy may still be growingIf PMI < 43 on a sustained basis => recession. Expect Fed to lower interest rates.

ISM Non-Manufacturing Business Activity Index – measures service sector business activity (non-manufacturing industries represent 80% of economy)

Service sector (medical care, communication, financial, consulting, entertainment, legal, insurance, lodging) is not as cyclical as manufacturingA reading of 50 shows the same percentage of managers reporting higher activity as lower activityIndex > 50 indicates growth in service industryIndex < 50 indicates contraction in service industry

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Market Analysis:Bonds: PMI > 50 and Y > YPot => P/P => DBonds => iBonds

Stocks: PMI > 50 and Y < YPot => Y/Y => profits => PStocks

Dollar: PMI < 50 => Y/Y => iBonds => dollar

ISM Purchasing Managers Index (SA)

30

35

40

45

50

55

60

65

70

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 1330

35

40

45

50

55

60

65

70

Recession

Manufacturing Activity

No Change in Manufacturing Activity

Annual % Change in U.S. Economic Output(Real GDP - Chainweighted 2005$)

3.1%2.9%

3.8%

3.4%

1.8%

3.1%2.9%

4.1%

2.5%

3.7%

4.5%4.4%

4.8%

4.1%

1.1%

1.8%

2.5%

3.5%

3.1%

2.7%

1.9%

-0.3%

-3.5%

3.0%

1.7%

-0.5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Source: Department of Commerce.

Keynesian ISLM ModelModel Explains 2 things:1. Determination of Output, Y2. Why Ye < YFE

Aggregate Expenditure Model: focuses on the relationship betweenspending (AE) and production (Y) assuming fixed price level.(nominal = real) => Y without P

AE = C + I + G + X-M

Macroeconomic EquilibriumAE = Y(no in inventories => no in production rate)

Assume no organic Y/Y %(Y/L) = 0L/L = 0

Domestic Production, GDP, Y

AE = C + I + G + XInventory

Equilibrium ConditionInflow = OutflowQS = QD

Foreign Production, M

Macro EquilibriumY = AE

The Circular Flow Diagram

YOutputIncome

AE = C+I+G+X-M

AE = Y

Y05Pot

Recent U.S. Economic PerformanceHousing Market Contraction

Y06Y08

Recession

Series of induced CMultiplier Effect

Y

CY

C

Autonomous Spending•Low pent up demand•Fewer investors•Tighter underwriting•Higher interest rates•Expected lower futurehome prices

AEE06

AE06

AE05

Inventory =>Homebuilders’ Y

Optimism => Firm’s production

Unplanned housing inventory

accumulation

Falling Home Prices

Falling HouseholdWealth

Falling HouseholdSpending

Rising Inventories

Lower Factory Production

Increase unemployment

Lower income

Negative Downward Spiral

•Salaries•Commissions•Bonuses•Tips

•Self-reinforcing spiral•Feedback Loop•Multiplier Effect•Sum of an Infinite Geometric Series

HELOC

Real Personal Consumption Expenditures (% chg from quarter one year ago)

13.73

5.945.25

4.72

0.77

3.242.52

10.78

7.838.87

11.04

1.222.43

5.536.73

8.35

10

6.6

4.55.55.1

7.36.4

2.1

5.4

2.32.3

6.3

3.64.44.64.6

0.8

-1.2

-5.4

-11.8

-8.9-8.8

-1.5

4

-16

-12

-8

-4

0

4

8

12

16

00Q1 01Q1 02Q1 03Q1 04Q1 05Q1 06Q1 07Q1 08Q1 09Q1

-16

-12

-8

-4

0

4

8

12

16

Durable Nondurable Total Services

(Furniture, appliances, autos) average growth = 6.0% (14%)

(Food, clothing, energy) average growth = 3.4% (29%)

Services average growth = 2.8% (57%)(Housing, transportation, medical care, recreation)

Total average growth = 3.3%

Autonomous Expenditure (Intercept) => multiple Y

Consumption:1. Household Wealth PAssets => Wealth => C2. Expected Future Income YE

t+1 => Ct

3. Price level P => W/P (real wealth) => C4. Interest rate r =>cost of borrowing => Cdurables

Investment:1. E

(t+1) Animal Spirits, business confidence2. Cost of Capital Real long-term interest rates3. Taxes 4. Cash flow Retained earnings, profits

Net Exports:1. PLU.S./PLROW PL U.S. => NX2. (Y/Y)U.S. / (Y/Y)ROW (YU.S. / YROW ) => NX3. Exchange rate (e/$ ) => NX

-$225,000

-$200,000

-$175,000

-$150,000

-$125,000

-$100,000

-$75,000

-$50,000

-$25,000

$0

$25,000

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

Current Account Balance

ISM-ChicagoBusiness Barometer Index (BBI)

(Measure of Manufacturing Activity in the Midwest Region)

Web: https://www.ism-chicago.org/index.cfm?Reassessments of seasonal adjustment factors in January

The Chicago chapter is an affiliate (one of ten local ISM chapters) of the Institute for Supply Management, (ISM). The Chicago group publishes their survey one business day before the national ISM manufacturing number is released.

The Chicago Business Barometer Index, BBI, moves in same direction as the national ISM numbers about 60% of the time and has a 90% correlation regarding their magnitude change. But for financial market traders, the direction is more relevant than the level of change.

Survey region covers the industrial heartland of Illinois, Indiana and Michigan, which contains a large part of the auto and auto parts sectors. The Federal Reserve monitors the Chicago NAPM report to study conditions in the manufacturing sector and check for signs of production imbalances.

ISM-Chicago, queries 200 purchasing managers regarding their business activity to assess if activity is rising, falling or unchanged. Survey results are compiled into a diffusion index, (BBI), based on a weighted average of 5 subcomponent indexes:New Orders (35% weight) - by purchasing agentsProduction (25% weight) - manufacturing outputEmployment (10% weight) – hiring by the companySupplier deliveries/Vendor performance (15% weight) – speed of supplier deliveryOrder backlogs (15% weight)

The Business Barometer Index (BBI) is a compilation of the 5 components listed above weighted by the given percentages. The BBI is a diffusion index, showing changes in month to month activity, but not actual levels of production.

Component number = % reporting rising + ½ % reporting no changeThe difference between % reporting rising and % reporting falling:(% - %) = (Index - 50) x 2. (Recall, 100% = % + no chg % + % and Index = % + ½ (no chg %)

ISM-Chicago is an effective gauge of business cycle turning points:If BBI > 50 indicates expansion in business activity. If BBI < 50 indicates contraction in business activity.

Data for the Chicago BBI is not the same data used to calculate the National ISM Index.------------------------------------------------------------------------------------------------------------------------------------------------------------------

Market Analysis:Bonds: Unexpected BBI => Y/Y => P/P => DBonds => iBonds

Stocks: Unexpected BBI => Y/Y => profits => PStocks

However if Y > YPot and BBI => expected interest rates by Fed. Res => PStocks

Dollar: BBI => Y/Y => profits & interest rates => Ddollar => $

ISM Chicago (Diffusion Index, SA)

30

35

40

45

50

55

60

65

70

75

00 01 02 03 04 05 06 07 08 09 10 11 12 1330

35

40

45

50

55

60

65

70

75

Recession

Chicago Index

No Change in Manufacturing Activity