Last Updated on 11 September, 2023 by Samuelsson

In this article, we backtest how low and high ISM Manufacturing readings influence the stock market.

The ISM Manufacturing Index or PMI is an important indicator of the health of the US manufacturing sector. The index is based on surveys and is published once a month.

A reading above 50 indicates that the manufacturing sector is expanding, while a reading below 50 indicates that it’s contracting.

ISM Manufacturing PMI and the stockmarkets – Backtest

We backtest the following:

• When the readings are above 50, we buy the open of the month (S&P 500),
• We sell at the open the next month (thus holding for one month)

The equity curve looks like this:

The strategy is invested 72% of the time, and the annual return is 7.3% (compared to 8.5% for S&P 500). Thus, most of the gains have come when readings are above 50, but it has also reduced drawdowns.

Let’s backtest to see what happens if we hold for a longer time period:

The table below shows when we have readings above 50, and we hold S&P 500 for N-months (see column one):

For example, if we hold for 12 months, the average gain per trade is 10.99% and we are invested 86% of the time (see last column called “exposure”).

How does ISM manufacturing PMI affect the stock market?

Our backtests show that the ISM manufacturing Index is not a good contrarian indicator. It works best when readings are above 50 (expansionary).

The main reason is probably that ISM is a lagging indicator. The numbers are already discounted by markets at the time they are published.

Related reading: Here you can read more about: ISM Manufacturing Index PMI and the stockmarket

The ISM Manufacturing Index PMI is a widely followed economic indicator that measures the health of the manufacturing sector in the United States. A PMI reading above 50 indicates that the sector is expanding, while a reading below 50 indicates a contraction.

A higher PMI reading generally indicates a stronger economy and can be seen as positive for the stock market, as investors tend to view economic growth positively. On the other hand, a lower PMI reading may indicate a slowing economy and potentially negative for the stock market.

However, it’s important to note that the stock market is influenced by a variety of factors, not just economic indicators, and stock prices can move up or down based on investor sentiment, political developments, and company-specific news.

Understanding the ISM Manufacturing Index PMI: A Comprehensive Guide for Traders

Traders and investors pay close attention to the ISM Manufacturing Index PMI, as it is a leading indicator of the overall health of the economy. A strong manufacturing sector is often associated with a strong economy, as it creates jobs, drives innovation, and stimulates growth. On the other hand, a weak manufacturing sector can indicate a slowdown in the economy, which can lead to decreased demand for goods and services, lower stock prices, and decreased investment in the stock market.

In addition to providing insights into the current state of the economy, the ISM Manufacturing Index PMI is also useful for predicting future economic activity. For example, if the index indicates that the manufacturing sector is expanding, it may be an indication that the economy will grow in the future, which could lead to increased demand for goods and services, higher stock prices, and increased investment in the stock market.

How is the ISM Manufacturing Index PMI calculated?

The ISM Manufacturing Index PMI is calculated based on a survey of purchasing managers in the manufacturing sector. The survey covers various aspects of the industry, such as production, employment, new orders, supplier deliveries, and inventory levels. The results of the survey are then used to calculate the index, which ranges from 0 to 100.

A reading above 50 indicates an expansion of the manufacturing sector, while a reading below 50 indicates a contraction. The index is calculated by subtracting the percentage of purchasing managers who report a decrease in activity from the percentage of purchasing managers who report an increase in activity.

How can traders use the ISM Manufacturing Index PMI to inform their trading decisions?

Traders can use the ISM Manufacturing Index PMI to inform their trading decisions in several ways. For example, they can use the index to determine whether the manufacturing sector is expanding or contracting, which can help them make predictions about the future direction of the economy.

In addition, traders can also use the ISM Manufacturing Index PMI to identify trends in the manufacturing sector. For example, if the index has been consistently above 50 for several months, it may be an indication that the manufacturing sector is in a long-term expansionary phase, which could lead to increased demand for goods and services, higher stock prices, and increased investment in the stock market.

Traders can also use the ISM Manufacturing Index PMI to compare the current state of the manufacturing sector with historical levels. This can help them identify patterns and trends in the sector, and make more informed trading decisions.

Conclusion

The ISM Manufacturing Index PMI is a crucial metric for traders and investors alike, as it provides valuable insights into the health of the manufacturing sector in the United States. By paying close attention to this index, traders can identify trends in the sector, make predictions about the future direction of the economy, and make more informed trading decisions.