When Manufacturing PMIs and Industrial Production Split

What do you do when two indicators seemingly measuring the same thing point in different directions? Those closely watching US manufacturing lately may have encountered this very conundrum, with purchasing managers’ indexes (PMIs) diverging from the Fed’s official industrial production measure. While the former suggests contracting activity, the latter—though not strong—has trundled along. The apparent conflict can be confusing, but understanding how each works could help clarify the situation, allowing investors to better see the underlying reality and how well expectations match it.

From last November through its latest July reading, the Institute for Supply Management’s (ISM’s) manufacturing PMI has been below 50, the dividing line between expansion and contraction. In other words, for nine months, less than half of firms the ISM surveys have reported growth in their business. While a timely read—PMIs are generally the month’s first economic report—they don’t tell you how much businesses grew or contracted in aggregate, only whether a majority saw output grow or contract. So even if a majority of firms reported declining activity, if the minority grew more than the rest shrank, actual output may still be net positive. This appears to have occurred last month.

Looking at just the manufacturing component of industrial production (stripping out mining and utilities), Exhibit 1 shows output grew in July and is up since December—despite the PMI’s sub-50 readings.

Exhibit 1: Manufacturing PMI vs. Output Levels

Source: FactSet, as of 8/18/2023.

Now, manufacturing output is down -1.1% from October 2022, when the PMI was 50. But as Exhibit 2 shows, monthly production has moved up and down since then, while the PMI steadily contracted. Note, too: The headline PMI aggregates several inputs besides production (e.g., new orders, employment and inventories), but ISM’s manufacturing PMI production subcomponent has contracted in seven of the last nine months.

Exhibit 2: Manufacturing PMI vs. Monthly Output Growth

Source: FactSet, as of 8/18/2023. Note: Y-axis truncated at -10.0% to avoid skew from April 2020’s manufacturing output, which declined -15.5% m/m.

Many pundits took manufacturing PMI weakness since last fall as a sign of recession. But there is a glaring problem here: Manufacturing is only 11% of GDP.^[i] The services sector is a far larger 71%—and its PMI has topped 50 since 2020’s lockdown recession, save for December’s one-month dip.^[ii] But as manufacturing production data also show, actual output has been more resilient than manufacturing PMIs suggest. Production volumes are clawing their way back even if the majority of firms’ business shrank.

Mid-month industrial production reports lag early-month PMIs by a couple weeks.^[iii] This is because PMI surveys are conducted over several days during the month—facilitating their early release. Tabulating output data requires waiting until month end. While it is easier to ask firms how business is going (soft data) than to count up everything they made during the month (hard data), the latter’s detail offers vital clues on the former’s initial read. In the current cycle, manufacturing output trends show flattish growth—and don’t confirm PMI’s headline message of worsening contraction.

The lesson for investors, in our view: Pay attention to PMIs’ early reads on the breadth of growth, but keep in mind these data are provisional—and fuzzy, especially near 50, when roughly equal amounts of surveyed firms are split on their assessment. Since PMIs don’t account for the size of their production, only output data can reveal growth’s magnitude. Although that can be volatile month to month, checking PMIs against output trends gives a better sense of what is actually going on under the economy’s hood—and whether narratives and sentiment covering it are accurate or not.