Leading indicators: PMI and co.

You can explain how a PMI is calculated and read, name typical leading and coincident indicators, and describe their limits.

Where is it going?

GDP is the broadest measure of an economy, but it is slow. The first estimate arrives weeks after a quarter ends, and it describes the past.

Investors want to know what comes next. A group of indicators tries to show turns in the economy before GDP does. They are faster and rougher, and they move markets because they arrive first. The best-known is a simple monthly survey.

Above 50: expansion

A leading indicator tends to change direction before the overall economy does. The most watched is the purchasing managers' index (PMI).

Every month, purchasing managers at hundreds of companies answer simple questions: were new orders, output, employment and other measures higher, the same or lower than a month earlier? The answers are turned into a diffusion index:

share answering "higher" plus half the share answering "unchanged".

With 40% higher, 30% unchanged and 30% lower, the index is 40 + 15 = 55. A reading of 50 means as many report improvement as deterioration. Above 50 signals expansion compared with the month before, below 50 contraction. The distance from 50 hints at how broad the change is.

In the US, the Institute for Supply Management (ISM) publishes widely followed PMIs for manufacturing and services. S&P Global publishes PMIs for many countries. Both are published early each month.

Leading vs. coincident

The Conference Board combines several series into indexes. Some of its components:

Leading indicators include new orders, building permits for houses, initial claims for unemployment benefits, and the spread between 10-year Treasury yields and the federal funds rate. They react early because companies order, hire and build based on what they expect.

Coincident indicators, such as payroll employment and industrial production, show the state of the economy now. Lagging indicators, such as the unemployment rate, often keep rising after a recession has ended. After the 2007–2009 recession ended in June 2009, US unemployment kept climbing until it peaked at 10% in October 2009.

A practical reading: a PMI that falls from 54 to 51 over several months says growth is slowing but still positive. A move from 48 to 49 says activity is still shrinking, but less broadly.

Common mistakes

Reading 50 as a level of output. It measures the share of companies reporting change, not how much is produced.
Treating one month as a trend. Survey readings are noisy. Look at several months.
Expecting a recession after every warning. Leading indicators have often signaled turns that never came.
Ignoring which PMI it is. Manufacturing is a smaller part of most economies than services.

The takeaway

Leading indicators such as the PMI try to show turns before GDP does. A PMI above 50 signals expansion, but early signals are often wrong.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the share of answers that counts half toward the index.

Tap the chart.

A PMI adds the share reporting higher activity and half the share reporting no change: 40 + 15 = 55.
2A manufacturing PMI moves from 48 to 49. What does that suggest?

Below 50 means more respondents report lower activity than higher. A rise toward 50 means the decline is easing.
3Why does a PMI arrive earlier than GDP?

Surveys are fast. GDP needs far more data and arrives weeks after the quarter.
4What is the main weakness of leading indicators?

Early signals are noisy. A falling index can recover without any recession following.

of 4 correct.

Sources

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