Adding PMI to your forecasting process for better visibility

Adding PMI to your forecasting process for better visibility

WHAT

The Purchasing Managers’ Index (PMI) is a leading indicator which gives insights on the current direction of economic trends in both the manufacturing and service industries. The index captures whether multiple market conditions are expanding, contracting or remaining stable based on a survey sent to representative companies. The index is used by both company decision makers and investors as an indicator on current and prospective business trends. For multiple businesses, in different industries, PMI shows remarkable correlation and as such predictive value.

RELEVANCE FOR DECISION MAKING

Monitoring PMI and its subcomponents is essential information to support decision making. Business leaders have to make production and various sourcing decisions based on expectations of customer demand. Should the demand trends remain stable, statistical techniques can give accurate predictions. However, if the end-consumer behavior is at a point of high uncertainty, external data (such as the PMI) is necessary for making such forecasts.

As a company downstream in the supply chain (close to the end-consumer, for example an FMCG/automotive manufacturer) changing business trends can potentially be captured rapidly (although it is then often too late to perform adjustments). However, if you are further upstream the consumer behavior is often unavailable and could even be impossible to quantify. In this case you will need to create your forecast based on the demand (forecast) of your customers. It is important to remember that there are multiple companies (all with their own stocks and reordering policies) between you and the end-consumer. Therefore, it is essential to monitor end-consumer behavior and stock levels, which PMI can give insights to.

Similarly, your investors will also be monitoring PMI as it is a leading indicator for economic conditions. As a company, you can adjust your company targets (stock levels, sales expectations) to anticipate on those changing conditions and keep your company attractive to its shareholders.

HOW TO UNDERSTAND PMI VALUES

The Purchasing Managers’ Index (PMI) is based over 5 major survey area: new orders, inventory levels, production, supplier deliveries, and employment. The survey questions whether the business conditions in these areas are improving, deteriorating or remain similar. The PMI result is a number ranging from 0 (=100% of the respondents indicating a deterioration) to 100 (=100% indicating an improvement) indicating what to expect compared to the month before. A reading of 50 indicates that we can expect nor a deterioration, nor an improvement, so similar conditions compared to the month before. This means if that if the PMI increases from 40 to 45 that a deterioration is still ongoing, but the deterioration is happening at a slower pace than the month before.

DIFFERENT PMI MEASUREMENTS

Different organizations publish PMI readings of the same geographical location with deviating numbers. The reason for this is a deviation either in the calculated survey areas (different weights attributed to components, or a different component altogether), or in the surveyed companies. The well-known ISM PMI of the United States assigns equal weights to each of the 5 survey areas (new orders, inventory levels, production, supplier deliveries, and employment). The IHS Markit manufacturing PMI (available in the US and many other countries) has a different weighting for each of the components (New Orders (30%), Output (25%), Employment (20%), Suppliers’ Delivery Times (15%) and Stocks of Purchases (10%)). Many other regional derivations of the PMI index are available: for China there is the IHS Markit PMI and the NBSC PMI (state owned), for Germany there is also an IHS Markit PMI and the IFO German Business Climate Index.

EXAMPLE

The following is an extract from IHS Markit’s monthly PMI overview presentation:

The worldwide PMI surveys indicated a strengthening of global economic growth in July 2020, led by rebounding activity from COVID-19 lockdowns. The JPMorgan Global PMI™ (compiled by IHS Markit) rose for a third successive month in July 2020, up from 47.8 in June 2020 to 50.8. The latest reading breached the no-change 50.0 level for the first time in six months to indicate expanding worldwide output across the combined manufacturing and service sectors.

The PMI had collapsed to an all-time low of 26.2 in April as governments around the world took increasingly drastic measures to contain the COVID-19 pandemic, including the widespread closures of non-essential businesses and restricting movement or travel. Since then the PMI has risen sharply as these containment measures have been eased, though the still-subdued level of the PMI reflects the fact that some measures remain in place, and some restrictions re-imposed upon rising cases of COVID-19.

CONCLUSION

For many businesses PMI shows a remarkable correlation. However, the many different PMI indices are just one of the many different indicators available. Key is to make a knowledgeable decision on which data to use and to analyze. Solventure LIFe has a database of over 10 million indicators available easily accessible in a tool. It has extensive capabilities of determining the combination of leading indicators for your businesses and markets. Contact us if you want help defining the predictive value of the PMI indicator for your business.