Business Activity Index |
The business activity index (PMI) is one of the indicators of the state of a particular industry in the country and in fundamental analysis refers to the “second tier indicators”. It does not have such a significant impact as Non-Pharm or GDP dynamics, but in combination with the analysis of the consumer price index and production data, it can cause local volatility of securities.
Business activity index: essence and calculation formula
Each enterprise that manufactures products of a particular industry is a kind of intermediary. It buys raw materials, processes them and sells them to the final / intermediate buyer. If a company incorrectly estimates demand and does not calculate the amount of required raw materials, this will ultimately affect the price:
- Little raw materials – the supply of goods is reduced and the demand is not fully satisfied. The price of the product rises.
- There are a lot of raw materials – the company is forced to increase its supply, thereby driving down the price.
The PMI is needed primarily by those responsible for procurement. By polling them, statistics are formed showing a change in one direction or another in the balance of demand for manufactured products and the supply of raw materials (warehouse stocks).
Purchasing managers receive a questionnaire in which they need to answer in the affirmative or negative for each of the questions that have their own weight in the index:
- New orders – 30%.
- Change in production volumes – 25%.
- Employment change – 20%.
- Change in the volume of delivery of products – 15%.
- Change in warehouse stock – 10%.
The PMI value can range from 0 to 100. The median value is 50%. A downward deviation means an economic recession: at 45% – the forecast is positive, 30-45% – the economy stagnates, the forecast is negative and investors are switching to defensive assets (gold, etc.), below 30% – there is a crisis in the country.
If the indicator is above 50%, the economy is considered to be growing, but a value above 60% is regarded as a potential problem of overheating of the economy. Investors are withdrawing money from the real sector and investing it in growing securities. To contain the bubble, the Central Bank raises the interest rate, thereby curbing a potential crisis of overproduction.
Investors refer to the PMI as an auxiliary one. The problem is the lack of unity in the coefficients correcting the value of the index and methods of conducting surveys. Another problem is conducting a consolidated analysis for all major areas of production, where there is also no single approach to the consolidation of statistics. The most famous (interesting for investors) methods are IHS Markit and ISM, which are applied to the assessment of business activity in the USA, China and Europe. The third problem for analysts is the limited access to data and the manipulation of statistics. An example is China, which has been slow to disclose industry information.
The PMI is not a reliable indicator and rather carries a psychological burden. Investors’ decision can be influenced not so much by its absolute value as by its deviation from forecasts. It can also serve as a signal that the stock market is overheating. If the quotes of the securities are at their maximum, and the PMI is growing, then there will soon be a sharp collapse, which will indirectly affect exchange rates.
Output… The business activity index is subjective and does not reflect the actual state of the economy. Nevertheless, the index can be used as an additional predictive tool in assessing the securities market, which indirectly affects currencies.