Why Greenspan Focuses On Business Buyers

Their data help the Fed set rates--and forecast economic trends

You may not care much about America's purchasing managers, but Alan Greenspan does. The economic data the National Association of Purchasing Management turns out every month, covering both the factory and nonmanufacturing sectors, are among the Federal Reserve chairman's favorite sets of numbers and play a role in determining how the Fed sees the economy. Wall Street pays a lot of attention to the purchasing managers' figures, too, especially now that the Fed is aggressively pushing rates higher. Indeed, the association's next report, due out on June 1, could give investors a hint about the central bank's next rate move when its policymaking body, the Federal Open Market Committee, meets in Washington on June 27-28.

The report that Greenspan loves to watch is called the Purchasing Managers' Index (PMI). Based on data from 350 to 400 NAPM members working in manufacturing, it "has a fairly robust track record of accurately predicting trends in the economy," says economist Joseph Liro of consultants Stone & McCarthy Research Associates in Princeton, N.J. For instance, the PMI turned downward a year before the 1990-91 recession. It also signaled the factory slowdown in 1997 and 1998, when the Asian financial crisis cut into demand for U.S. exports.

NET CHANGES. The PMI, reflecting data for the previous month's activity, comes out at 10 a.m. on the first business day of each month. You can check out the results at www.napm.org, but Greenspan doesn't have to--the NAPM slips him a copy beforehand.

The PMI is a composite of new orders, production, vendor deliveries, inventories, and employment. Each of the NAPM results is expressed as a "diffusion index." A diffusion index is based on net change, or the difference between the number of purchasers reporting an increase in activity and those reporting a decrease. The survey doesn't reflect the magnitude of the increases or decreases, only that purchasers are seeing a change. A PMI reading of 50% means the number of increases and decreases are equal. Over 50% indicates that the manufacturing sector is expanding--and thus the U.S. real gross domestic product is growing. Since February, 1999, the PMI has been cruising well above 50%, suggesting a very healthy manufacturing sector and economy (chart).

Lately, the markets have been focusing a lot on the NAPM's index of prices paid, which is not included in the overall PMI. An increase tells you that companies are having to shell out more for supplies and materials. So far in 2000, the prices-paid index has been soaring, hitting a five-year high of 79.8% in March.

MARKET JITTERS. That's not just because of the spike in energy prices. The NAPM has reported that other industries, including paper, aluminum, and plastics, are beginning to enjoy some pricing power for their products. Since any hint of rising inflation suggests more Fed hikes in interest rates, these increases in the price-paid index have been sending jitters through the financial markets for the past four months.

The vendor-delivery index is another leading indicator of price pressures. A rise in the index suggests that excessive demand or production bottlenecks are forcing businesses to wait longer for supplies to be delivered. That's a typical precursor to price increases. Since early 1999, vendor deliveries have been getting longer. In April alone, the index jumped to 55.6%, from 54.1% in March.

The NAPM's other report, focusing on nonmanufacturing, relies on the association's many members who buy supplies for brokerage houses, hospitals, governments, and restaurant chains, among other organizations. But compared with the 52-year-old PMI, the purchasers' nonmanufacturing report is just a toddler, making its debut in June, 1998. It covers the 80% of the economy outside of manufacturing, including services, construction, mining, and agriculture. The nonmanufacturing report does not have a composite index yet, but the report highlights its business activity index. Released on the third business day of the month, the survey covers much of the same ground as the PMI, including employment, inventories, and prices (table).

Because of its short history, the business activity number is not yet seasonally adjusted. So it tends to drop in December and January. Liro says the forecasting value of the nonmanufacturing index is still unknown, since the data have not yet covered a recession. "You can't stress-test these indexes unless there's a stress on them," he says. Even so, he thinks "in time, the nonmanufacturing index will become a very valuable tool" for forecasters.

For now, the purchasers' survey shows that nonmanufacturing activity is continuing to expand--but also that the rate of growth is beginning to slow. In particular, says Ralph G. Kauffman, chair of the NAPM's Nonmanufacturing Business Survey Committee, some members report that "they are cutting back on capital expenditure plans." This, he believes, is an early indication that "Fed actions are taking hold."

Kauffman says that within the next year, the NAPM may consider doing another survey focused solely on services. Since services account for more than half the economy, such a report would grab a lot of attention on the Street.

Still, the purchasing managers already have an impressive history of signaling changes in the economy. So follow Greenspan's lead and watch that PMI. It can help you protect your portfolio from the Fed's tightening maneuvers.

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