ISM Manufacturing Composite Index

Always Check The Economic Calendar

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What Is The Institute For Supply Management (ISM) Manufacturing Composite Index?

The manufacturing composite index from the Institute For Supply Management is a diffusion index.  It is calculated from five sub-components of a monthly survey; there are eleven sub-components in total.  The survey respondents are purchasing managers from roughly 300 manufacturing firms nationwide.

The entire survey asks purchasing managers about:

  • general direction of production
  • new orders
  • order backlogs
  • their own firm’s inventories
  • customer inventories
  • employment
  • supplier deliveries
  • exports & imports
  • prices

The five components of the composite index are:

  • new orders
  • production
  • employment
  • supplier deliveries
  • their own firm’s inventories

Note that the five components are equally weighted. The questions are qualitative (not quantitative, so no specific numbers).  Each question is adjusted into a diffusion index which is calculated by adding the percentage of positive responses to one-half of the unchanged responses.

WHY IS THE ISM MANUFACTURING COMPOSITE INDEX IMPORTANT?

The ISM manufacturing composite index indicates overall factory sector trends. The relevance of this indicator is solidified by the fact that it is available very early in the month and is not subject to revision  –this lowers the probability of reporting shenanigans.

Investors need to keep their fingers on changes in the economy because it dictates how their investments will perform. Tracking economic data such as ISM manufacturing lets investors know what the economic backdrop is for various markets.

Remember, the stock market likes to see healthy economic growth because that translates to higher corporate profits.  And, the bond market prefers slow growth and is very sensitive to whether the economy is growing too quickly which gives rise to inflationary pressure.

ISM manufacturing data give a detailed look at how busy the manufacturing sector is and where things are headed. Since the manufacturing sector is a major, major source of cyclical variability in the economy, this report has a big influence on the markets.  And remember, it cannot be revised once the number is released.

A few ISM sub-indices provide insight on commodity prices and clues regarding the potential for developing inflation. The Federal Reserve keeps a close watch on these sub-indices to help determine the direction of their interest rate decisions (in case inflation signals are flashing). Since inflation leads the bond market, the bond market is highly sensitive to the data listed in these sub-indexes.

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ISM Manufacturing Correlations

The bond market will rally (fall) when the ISM manufacturing index is weaker (stronger) than expected. Equity markets prefer lower interest rates and could rally with the bond market (existing bonds are valued higher when interest rates are expected to fall).

Also, a healthy manufacturing sector, indicated by rising ISM index levels,  increases the expectation of higher corporate earnings and is bullish for the stock market.

The level of the ISM manufacturing index indicates whether manufacturing and the overall economy are growing or declining. Historically, readings of 50 percent or above are associated with an expanding manufacturing sector and healthy GDP growth overall.

ISM Manufacturing, What Do The Numbers Mean?

Readings below 50 indicate a shrinking manufacturing sector but overall GDP growth is expected to remain positive until the ISM index falls below 42.5 (based on statistical data through January 2011). Readings between 42.5 and 50 suggest that manufacturing is in decline while GDP is still growing (very slowly).

As mentioned above, the various sub-components contain useful information about manufacturing activity. The production component is related to:

  • industrial production
  • new orders to durable goods orders
  • employment to factory payrolls
  • prices to producer prices
  • export orders to merchandise trade exports
  • import orders to merchandise imports.

Vendor (supplier) deliveries are another important component of report. The more slowly orders are filled and delivered (inventory turnover), the stronger the economic growth and expectation of higher inflation. When orders are filled quickly, it means that producers don’t have as many orders to fill (or there is a supply glut).

The ISM manufacturing composite index and its sub-components may show monthly volatility, so check the three-month average of the monthly levels to spot the trend and calculate the probability of an interest rate change.

Sails Down

Always check the economic calendar.

All sails are down for the weekend.

Fed rhetoric is that rate hikes are not likely to happen in the relative future (relative to what exactly?).  This is the type of FedSpeak that throws an anchor around the dollar.  The dollar losing value buoyed up commodity prices resulting in higher demand for the commodity currencies (aud, cad, nok, nzd, etc…).  I will be keeping an eye out for the wave two pullback.

I always stay port-side with conservative lot sizing and wide stops when I see a pirate get-together listed on the economic calendar.

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Sails Up

Apply risk management to your alternative investments.

Short AUD/JPY

I expect the easterly winds to push down the AUD/JPY this week.  The Reserve Bank of Australia  (recent dovish rhetoric) did not hike rates recently.  Also the Chinese slowdown is putting overall downward pressure on commodity currencies.

However, I always rely on charts for navigable water, such as:

  • a weekly high-test with cci divergence
  • daily decelleration with cci divergence
  • top of a head & shoulders pattern on the daily chart

The Japenese Yen, a safe-haven (funding) currency, may rise above the AUD a bit this week to offset the expected decrease in the DXY.  I will be on the lookout for an updraft to the DXY to signal a flattening or decreasing of the Yen.

Use wide stops, in this case above JPY89.  Cap risk at a predetermined limit that does not change unless something outside of emotion justifies the change.  My target holding period is no more than 10 days, depending on the Winds.

trade closed:  stopped out at JPY89.2   risk capped at -1.9% of  equity.

Short NZD/USD

High probabilility of the DXY  rebounding off 93, good probability of weekend gap in price action to fall, good CCI divergence on daily & weekly.  Conservative lot size and wide stop due to Fed meeting this week.  Stop loss set above USD00.75

trade closed:  stopped out at USD.755  risk capped at -1.1% of  equity.

Read up on the Sintra Accord.

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fairweather & following seas