ISM Services vs Manufacturing regarding cycles

The Institute for Supply Management (ISM) provides two key indices that gauge U.S. economic health: the Manufacturing PMI (Purchasing Managers' Index) and the Services PMI (formerly Non-Manufacturing Index).

Among these, the Manufacturing PMI is often considered more representative of the economic cycle, especially concerning cyclical industries and capital-intensive companies. Here's why:

Sensitivity to Economic Fluctuations

Manufacturing activities are closely tied to economic cycles. During economic expansions, demand for manufactured goods—such as automobiles, machinery, and electronics—rises, leading to increased production. Conversely, during downturns, demand wanes, and production slows. This direct correlation makes the Manufacturing PMI a reliable indicator of economic turning points. In contrast, the Services PMI encompasses a broad range of industries, including healthcare, finance, and retail, which may not experience the same degree of cyclical volatility. Services like healthcare and education often maintain steady demand regardless of economic conditions, rendering the Services PMI less sensitive to economic cycles.

When the economy slows do schools start firing teachers? When the economy heats up do consumers upgrade their insurance premiums?

Capital Intensity and Investment Cycles

Manufacturing sectors are typically capital-intensive, requiring substantial investments in machinery, equipment, and facilities. These investments are closely linked to business confidence and economic outlook. In periods of economic uncertainty or high interest rates, manufacturers may delay or reduce capital expenditures, directly impacting production capacity and employment. For instance, in June 2024, capital-intensive manufacturing sectors like transportation equipment experienced contractions, reflecting caution amid economic uncertainties and tighter monetary policies. 

Implications for Cyclical Companies

Cyclical companies—those whose performance is closely tied to the economic cycle—are significantly influenced by manufacturing activity. Industries such as automotive, construction, and heavy machinery experience increased demand during economic booms and face challenges during recessions. The Manufacturing PMI, by reflecting new orders, production levels, and supplier deliveries, offers insights into the health and future prospects of these cyclical industries.

Conclusion

While both ISM indices provide valuable insights into the U.S. economy, the Manufacturing PMI's direct correlation with economic cycles and its reflection of capital investment trends make it a more representative indicator for assessing the economic cycle and the performance of cyclical, capital-intensive companies.