Relationships Matter: Supply Chain and PMI

Michael Normyle – Nasdaq’s US Economist joins IBKR’s Jeff Praissman to discuss the relationship between PMI and the Supply Chain.

Summary – IBKR Podcasts Ep. 156

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jeff Praissman 

Hi everyone. Welcome to IBKR podcasts. I’m your host, Jeff Praissman. It’s my pleasure to welcome back to the IBKR podcast studio, Nasdaq’s US economist, Michael Normyle. 

Michael Normyle 

Thanks for having me back. 

Jeff Praissman 

Oh, my pleasure. How are you doing? 

Michael Normyle 

Doing well, thank you. 

Jeff Praissman 

It’s always great to see you on our monthly podcast on economics that we do together and  today is no exception.  

In the past, we’ve talked about PMI and supply chains. But today, we’re actually going to kind of dig down deep and discuss how they relate to each other. So I’d like to start with.. for our listeners, a refresher on the PMI.  

Can you tell them what exactly is the PMI and why is it useful? 

Michael Normyle 

Yeah. So PMIs are Purchasing Managers’ Indexes. They’re a survey of purchasing and supply executives generally within a specific region and industry. So typically at the country level and often divided between Manufacturing and Services. And so when you look at a PMI, a reading below 50 generally means that activity is contracting and above 50 signals expansion.  

And so it’s useful because it provides insights from decision makers within that industry and because it’s timely. So we often get flash or preliminary PMIs by the third week or so of the month. So for example, by late April, we already have an idea of what the PMIs are looking like for that same month.  

The final PMI is then released at the beginning of the following month. But by comparison, the kind of hard data for Manufacturing, for example, like industrial production, you wouldn’t get the April reading until the middle of May.  

So markets like that. It’s a really timely indicator of what’s happening in an industry. And then on top of that, there are sub-indexes that give insights into specific areas like demand for new orders or prices paid by these purchasing managers. And as well as employment. So it could be really informative. So if you take the ISM Manufacturing PMI for the US, that’s derived by applying equal weights to the sub-indexes, production, employment, supplier delivery times and inventory change. 

Jeff Praissman 

You kind of mentioned really quickly in the beginning of the explanation.  We hear PMI a lot in the news and I think a lot of people may just think it’s US specific. But, really, you had specifically mentioned region or country.  

So there’s PMIs for different countries or different continents, correct? There’s like a Eurozone PMI and I would assume like a China PMI. It’s not just for US. I think that’s kind of important to point out to our listeners. 

Michael Normyle 

Yeah, there’s a lot of PMIs. So not only by country like US, Canada, China and like you said by region for the Eurozone. And then within the US, the regional Fed banks also have their own PMIs. So you can get like for example, for the New York Fed, there’s the Empire State Manufacturing PMI. So it can get even more granular, at least for the US. 

Jeff Praissman 

That was for US. What about the Eurozone and China? Is it just one PMI for each or do they have the Manufacturing, the more kind of granular PMIs as well? 

Michael Normyle 

Well, of course, for Europe there are country level PMIs available that can be aggregated and stuff like that into the Eurozone. And of course, the UK has their own PMI. China, like the US, has two PMIs. There’s an official PMI and then a private PMI. So people look at both of those. 

Jeff Praissman 

And for the US PMIs, what have they been signaling for the past couple of years? And were they correct? 

Michael Normyle 

Yeah. So I think the last time we talked about PMIs, we were talking about the Two-Speed Economy that they were signaling. So the Services sector was expanding. The Manufacturing sector was contracting. And so for the US, there’s two main PMIs, one from the Institute for Supply Management or ISM and one for S&P.  

And so they’ve got different methodologies, so the results are a little different, but both have generally shown that the US Manufacturing sector has been quite weak over the last couple of years.  

So starting in late 2022, the ISM Manufacturing PMI fell below 50 and stayed there for 16 months. At the same time, the S&P Manufacturing PMI fell below 50 and stayed there for 13 out of 14 months.  

So both were clearly saying the Manufacturing sector was contracting, but that was more negative than the hard data showed. So Manufacturing output, as measured by industrial production, more or less moved sideways instead of contracting and Manufacturing employment actually rose a little bit. 

Jeff Praissman 

What has the PMI recently been signaling for the US Manufacturing sector? 

Michael Normyle 

So the PMIs have finally turned around. The ISM PMI just rose above 50 for the first time since October of 2022 in March, but it’s also been trending up since late last year. S&P PMI has been above 50 for three straight months and has been in an upswing since mid 2023, although the preliminary reading we got for April did just dip to 49.9, so just below the expansion contraction threshold. But we’ll have to see if that gets maintained in the final reading that we get at the start of May.  

But right now, both have clearly been trending up and the last final readings that we have for both are above 50, signaling expansion for the Manufacturing sector. 

Jeff Praissman 

And Michael, what about the Eurozone in China? 

Michael Normyle 

So the S&P Manufacturing PMI for the Eurozone is still well below 50. It’s at just 45.6 and it’s been under 50 for nearly two years. However, it has generally trended higher since mid 2023.  

So basically, that means that the Manufacturing sector, it’s still contracting but slower. The UK Manufacturing PMI, though, did just pop above 50 for the first time in a year and a half in March.  

Although like the US, the preliminary April reading is just back below 50. So we do see that the Manufacturing revival, it’s still kind of developing in Europe. In China, there’s, like I mentioned earlier, two PMIs. So the official PMI just moved back above 50 after five months in contraction. And so the Manufacturing contraction in China was much shorter than the ones that we saw in the US and Europe where they were one and a half to two years, basically.  

Jeff Praissman 

Kind of going back to the Manufacturing sector. Obviously Manufacturing takes supplies. How have supply chains been over the past few years? Have they been operating efficiently worldwide? Or have they kind of run into some issues based on predictions or based on outside factors such as you know? I know we’re a little bit past COVID but that’s sort of.. obviously a huge factor in everything. 

Michael Normyle 

Yeah. So the last few years have definitely been a tough, tough period for supply chains. So for a few reasons. First, COVID, like you mentioned, disrupted supply chains, so lots of factories had to shut down early on in the pandemic because being in such close proximity made it easy to spread COVID.  

And then even once factories were able to reopen, you of course had workers in and out with COVID. And then there was also “The Great Resignation” kind of period that impacted factories certainly. And then there’s also the demand side, where at least focusing on the US, when everyone was locked down, there was a jump in spending on goods relative to pre-COVID levels since people couldn’t spend money on Services as easily.  

So there is this big increase in demand at a time when supply was constrained and so that really stretched supply chains making it difficult to get things as simple as shipping containers to move goods around the world.  

But as economies reopened and people shifted back to spending on Services, supply chains have healed. So, of course we’re still seeing some disruptions, including from geopolitical events like the attacks in the Red Sea, meaning that shipping containers avoid the Red Sea, resulting in longer shipping times. 

And then also you had the Key Bridge collapse at the port of Baltimore recently. But compared to COVID, these have been much more manageable for the supply chain. So they’ve really healed pretty significantly from peak disruptions that we saw a couple of years ago. 

Jeff Praissman 

Besides the actual disruptions, such as the Red Sea or the bridge collapsing in Baltimore, or even COVID, what about the relationship that perceived or maybe as you mentioned earlier, that the PMI kind of overstated the slowdown in the past couple of years.  

How does that affect the supply chain? Do companies purposely lower employee count or slow the materials down in order to prevent having too much in stock and lowering the price that way? 

Michael Normyle 

Yeah, I think we’ve seen a shift in inventory management, supply chain management from pre-COVID to post-COVID.  

So pre-COVID, supply chains were really designed to be “just in time” was what it was called. So Walmart was a big kind of pioneer in that, where companies tried to keep inventories low and their suppliers were able to see speed of sales, inventory levels and things like that so that they could predict what would be needed and get it there just right when it’s going to be needed.  

Since COVID, though, there’s been a shift to “just in case” inventory and supply chain management, where companies want to build a bit more of a buffer into their inventories to avoid those shortages that were faced during COVID.  

But either way, in both cases, it’s still about predicting demand. And with “just in case” you just keep a little bit more of a buffer. And of course, there’s no perfect forecasting.  

So there will always be cases where maybe a company has too much of something and too little of others. 

Jeff Praissman 

The last time we talked, as you mentioned earlier, we talked about this Manufacturing economy versus the Service economy. How currently is the Manufacturing economy doing compared to the Service Economy? 

Has it made some strides to kind of level it up a little bit or, in fact, their overall contribution to the US economy? 

Michael Normyle 

Manufacturing is really quite a small piece of the US economy and that’s really a decades-long downtrend that we’ve seen in the share of the economy coming from Manufacturing versus Services.  

So if you look at gross value added right now, Manufacturing is just 11% of the US economy. Actually even fewer jobs are in Manufacturing. Only 8% of jobs are in Manufacturing.  

In comparison, Services, it’s nearly 80% of gross value added and nearly 85% of private sector jobs.  

Over the last few decades, we’ve seen a lot more people moving into the service sector in terms of jobs. Of course, there is also all the movement of Manufacturing jobs out of the country a couple of decades ago. And then, of course, the mechanization of Manufacturing and requiring fewer people to be employed in Manufacturing. 

Jeff Praissman 

How about the Eurozone and China? Are they following the same trends as the US or are they.. You always see “made in China”. Or is China just still manufacturer heavy I guess would be question? 

Michael Normyle 

They’re definitely bit more Services oriented than Manufacturing, but Manufacturing is more important in the Eurozone and China than in the US.  

So in the Eurozone, Manufacturing is 15% of gross value added, compared to 11% in the US and Services is 2/3 of gross value added for the Eurozone.  

And of course, within countries there will be some variation within the Eurozone. But in China, Manufacturing is nearly 30% of gross value added, so close to triple what it is in the US and Services are only about 50% of gross value added. 

Jeff Praissman 

Looking further down the road, what are the PMIs signaling for the US? 

Michael Normyle 

So both the ISM and S&P PMIs are in upturns and they’re above 50, so we should expect the Manufacturing sector to pick up.  

But since they’re both kind of just above 50, we shouldn’t expect a strong rebound in Manufacturing necessarily just yet. So it’s still kind of a modest upturn that they’re signaling right now. 

Jeff Praissman 

How about for the Eurozone in China? 

Michael Normyle 

It’s a similar story for China. Its PMIs are pointing to a rebound in Manufacturing. But again, we should expect it to be relatively modest for now. For Europe, the Manufacturing rebound is still developing, but it’s important to mention that this is actually a global story. The Global Manufacturing PMI turned up in mid 2023 has been above 50 for two months now. So we’re seeing a global recovery in Manufacturing too, beyond just Europe, China and the US. 

Jeff Praissman 

Michael, this was great. I want to thank you for stopping by our IBKR Podcast studios. Is there any final thoughts you want to leave our listeners with regarding PMI and supply chains? 

Michael Normyle 

It will be interesting to see if the upswing can continue in the Manufacturing sector, especially within the US. If we get, instead of the Two Speed economy we were talking about before, we can have a One Speed economy, where they’re both going in the expansion direction.  

So that’s something to watch. And I think in terms of supply chains, obviously we’ve had these disruptions recently. So I think we want to keep an eye on that, make sure that they don’t get any worse. And I think we’re in a good place with them that they should be manageable and not have too big of an impact on the economy. 

Jeff Praissman 

And for our listeners, for more from Michael and NASDAQ, please go to our website under Education to view previous NASDAQ webinars, as well as previous podcasts. Thank you for listening.  

Until next time, I’m Jeff Praissman with Interactive Brokers.