What PMI Tells Us About the Economy

Bob Johnson: This week's chart focuses on data from ISM on purchasing managers. It's a quick survey taken at the end of every month to give us a feel for where the economy is heading. The original index was developed by Herbert Hoover, and it was meant to give people a quick up-or-down ­[question]--"Is the economy getting better or worse?"--that they can ask in a hurry rather than waiting for people to add up all the numbers and finding out the results three or four months later. So, it was meant to be a very early indicator, and that's why it's such a popular indicator. And it has been a very good indicator over time, talking about the strength of the economy and where we might see turns in the economy as well.

This week's particular chart shows the relationship between GDP growth rate--a broad measure of economic activity--and the PMI ratio. And as you can see, if we batch these by increments of five, you have the best results the higher the PMI number. It's what they call a monotonic relationship. Each time one gets better, the other gets better. And it's a straight relationship.

One curious thing about the index is that as we go and get better from group to group, the one that provides the most value is when we dip under 45. Then, the gap you can see there between that bar and the rest of them is really dramatic, and that's when the signal really sends something that is very, very meaningful.

Right now, at the moment, the index stands at about 58 on a three-month moving average basis. That would suggest that the economy is going to grow well over 3% in the year ahead. That's perhaps a bit aggressive. But nevertheless, that's what the index is indicating at the current moment.