ISM Non-Manufacturing Index: Meaning and Types

What Is the ISM Non-Manufacturing Index?

The ISM Non-Manufacturing Index is an index that measures the economic condition and performance of service-based companies. It is now called the Services Purchasing Managers' Index (PMI). The index is based on surveys sent to purchasing and supply companies of more than 400 services firms. It is part of the Institute of Supply Management's ISM Report On Business—Manufacturing and Services. As a barometer of the overall economy, the index shows trends in the service sector. It is compiled by the ISM.

Understanding the ISM Non-Manufacturing Index

The PMI is compiled and issued by the ISM and was developed in coordination with the U.S. Department of Commerce to measure various activities within supply management. The PMI is divided into three separate categories: the Manufacturing PMI, the Hospital PMI, and the Services PMI. These indexes guide supply management professionals, business leaders, economists, and government officials by monitoring the economic conditions of the nation.

As noted above, the ISM Non-Manufacturing Index (or the Services PMI) provides stakeholders with insight into the state of the nation's services sector. The index contains a diffusion index based on survey data. A diffusion index summarizes whether purchase managers believe the market is expanding, contracting, or staying the same.

The Services PMI contains the economic activity of more than 15 industries, some of which include

• Accommodation and food services 
• Agriculture, forestry, fishing, and hunting 
• Arts, entertainment, and recreation
• Educational services
• Finance and insurance 
• Healthcare and social assistance
• Management of companies and support services
• Professional, scientific, and technical services
• Public administration
• Real estate, rental, and leasing 
• Retail trade
• Transportation and warehousing 
• Wholesale trade
• Utilities 
  

The Services PMI comes out in the first week of each month and provides a detailed view of the U.S. economy from a non-manufacturing standpoint. Data in the index is not very volatile. Trends can go on for months, which is valuable for analysts who focus on making long-term economic forecasts.

Special Considerations

Monitoring the Services PMI can help investors better understand the economic conditions within the U.S. Some service sectors may experience growth while others contract, which can be helpful when choosing which industry to invest in via equities or corporate bonds. The Services PMI provides significant information about factors affecting total output, growth, and inflation.

When the business activity index increases, investors may infer that the stock markets should increase because of higher expected corporate profits. When used alongside the ISM Manufacturing PMI, the industry coverage between the two reports account for a significant portion of the goods and services produced in the U.S. economy—measured by gross domestic product (GDP).

Components of the ISM Non-Manufacturing Index

The ISM report has several components that measure business growth or contraction, as well as many other factors that go into the supply management process. Below are a few of the key areas that are covered within the report.

Business Activity

The services PMI report provides an overall outlook for business activity in the United States. The PMI index is reported as a number. A reading above 50 represents economic growth or expansion while a reading below 50 represents a contraction.

The report also shows the industries that experienced growth in business activity compared to the prior month while showing which industries contracted.

New Orders

New orders include new sales that were recorded for the month and whether businesses have seen increases or decreases in demand for their services versus prior months. For example, retailers might report a high demand for their services at year-end due to the holiday season.

New orders help provide insight as to the demand for services by consumers and businesses and, ultimately, whether economic growth is increasing or decreasing.

Employment Trends

Employment activity in the services sector is measured monthly. The report shows whether employment grew or contracted each month. The employment figures are compared and contrasted to previous months. 

The report also provides insight into the level of tightness in the labor market, meaning whether or not supply managers were able to fill vacant positions with qualified applicants. If there are more jobs than applicants, it can indicate a healthy, growing economy.

Conversely, if there are more workers than open positions, it can indicate that economic growth is slowing and unemployment may increase.

Inventories

Inventory levels are tracked each month to show whether there's a reported increase or decrease. For example, if a company experienced no sales growth, its inventory levels might have remained the same due to a lack of demand. 

The overall trend in inventory levels, and whether they're increasing or decreasing, can help provide insight as to the level of demand for the services within specific industries. It can be a leading economic indicator when demand is high and it leads to lower inventory levels. As such, it demonstrates the health of consumer spending as higher spending leads to higher economic growth.

Prices

The report also shows which service industries reported an increase in prices paid for various raw materials and goods. The price paid could also include services that companies needed, such as software services. 

The prices paid for services and goods by companies may indicate inflation, which measures how much prices increase in an economy. Inflation is likely if businesses pay higher prices. Higher prices could also indicate a shortage in supply for particular goods.

ISM Non-Manufacturing vs. Manufacturing Index vs. Hospital Index

As noted above, the ISM reports economic conditions through three indexes. The first is the Services (Non-Manufacturing Index) PMI while the other two are the:

• Manufacturing PMI: This index used to be called the ISM Manufacturing Index. It surveys manufacturers to determine the level of output and economic activity in production facilities as well as the commodity purchases and inventory that are used to produce those goods.
• Hospital PMI: The ISM collaborated with the Association for Health Care Resource & Materials Management to develop this index. It is based on a survey of hospital supply executives about hospital supply chains. The index, which covers ambulatory, inpatient, and nursing home-type facilities, is used by supply chain stakeholders as well as healthcare policymakers and executives.
  

The Bottom Line

Leading indicators can help economists and investors understand where the economy is headed. And there are a number of these indicators, including the ISM Non-Manufacturing Index. Now called the Services PMI, it provides insight into how the executives of service companies feel and how these companies are operating. This monthly report provides a reading—anything above 50 suggests growth while a reading below 50 points to a drop in economic activity. As an investor, you can use this information to make important decisions about where to invest your money.