When looking at economic data as predictors of Presidential election outcomes, most of us tend to focus on items like inflation, unemployment rates, the "misery index," job creation figures, or GDP growth. All of these are important items, but none really are great predictors in and of themselves. For example, there is the fact that no sitting President has won an election with unemployment above 8% as it is now (except FDR). Of course, this gives Republicans hope and a talking point to use against Obama. Naturally, he counters with the number of jobs created or the number of consecutive months where jobs were created under his "leadership." However, many economists and political pundits have noticed the high correlation between electoral outcomes and a much overlooked piece of data, the ISM manufacturing index.
So, what exactly is the ISM manufacturing index? Basically, it is a composite of five factors from among eleven total that are indexed. They are based on a monthly survey of managers at about 300 manufacturing companies nationwide. It is important to investors because it is released on the first business day of the month. Furthermore, it is not subject to revisions at a later date. It is more indicative of overall economic activity than its counterpart- the ISM non-manufacturing index- because that index is subject to extreme seasonal volatility that requires adjustments later down the line. Also, it is a qualitative survey and does not ask for specific numbers although the scores derived from the particular components used and the overall index score predict other economic data released later in the month that is quantitative in nature.
The five components are new orders, production, employment, supplier deliveries, and inventory (their own). Obviously, one can see where component scores can affect other economic data. Production indicates overall industrial output while the new order component predicts durable good sales and orders. The employment component predicts not only unemployment rates overall, but manufacturing/non-service sector/ non-public sector job creation. Supplier deliveries will indicate producer prices which will, in turn, affect consumer prices and inflation rates. Finally, inventory indicates whether or not consumer goods are moving.
Investors keep a close watch on the ISM because it is a fairly accurate indication of the economic backdrop upon which they will make decisions with regards to various markets. For example, the stock market likes to see healthy numbers because that translates into higher corporate profits. Conversely, the bond market prefers slower growth because it fears inflationary pressures. Because it is released early in the month with no later revisions, it shows how busy the manufacturing sector is and where management within that sector believes it is headed.
With that said, what does the ISM manufacturing index generally tell us? Under Obama, when the unemployment rate has shown increases, the ISM index declined an average 1.52 points. When there has been no change in the unemployment rate, the ISM has declined, on average, by half that amount at 0.77 while when the unemployment rate has decreased, the ISM has risen an average 0.37 points. The greater the unemployment rate drops on a month-to-month basis, the greater the increase in the ISM. Hence, increases and decreases in the ISM are pretty good indicators of the unemployment rate when it is announced slightly later in the month. As far as job creation is concerned, the less number of jobs created, the greater the decline in the ISM index.
Historical data on the ISM goes back to 1948 so it is a fairly valuable tool with respect to presidential elections. Over the course of an entire presidency, the lowest average ISM was under George H.W. Bush at 47.85 followed by Gerald Ford at 49.27. Both lost their reelection bids as sitting Presidents. Now, obviously other factors likely played in their losses, but the fact remains that they are the only incumbents not reelected with an ISM under 50. The only other incumbent denied a second term was Jimmy Carter who had a 4-year ISM index average of 53.23, which is fairly healthy but the previous damage to his Presidency on the economic front plus the Iranian hostage crisis spelled his defeat.
Looking at the 6-month average heading into an election, it was an average of 49.6, or under the 50 point threshold, when the Oval Office changed party hands. Conversely, when the party in power stayed in power at the White House, the 6-month average was a healthy 55.3. On an overall basis of the four-year stint as President, when there was a power shift, the average ISM index was 50.4 versus 64.1 when the party retained the White House.
When Truman's party lost power in 1952, the average leading into the election was 47.6. When Kennedy defeated the Republican Nixon in 1960, that average was 44.9 and when Obama took office, the average was 46.9. So what does that tell us about 2012? For the last two months, the ISM has been slightly under 50. The 3-month average falls at about 50, the breaking point. An ISM of 50 spells almost certain defeat for an incumbent President. However, the only exception was 1984 when Reagan carried a 40.9 ISM into the election and won in a landslide. But, the October ISM in 1984- the last one to be digested before that election- was up 5.4 points over September indicating economic optimism. Compare that with the 5.9 point ISM decline in October 2008 when there was anything but economic optimism.
The point here and now is that Obama's ISM average is borderline at 50.6 which is one of the lowest on record. The only two lower were Ford and Bush I and they both lost. Barack Obama is dangerously close to that territory. As I have noted, over the course of an entire Presidency, incumbents have won with relatively low scores overall, but never with a six or three month average heading into Election Day with an ISM under 50 EXCEPT Ronald Reagan in 1984. The "hope" here is that obviously Barack Obama's name cannot be said in the same breath with that of Ronald Reagan. To paraphrase Lloyd Bentsen: "We all knew Ronald Reagan, and you sir (Obama) are no Ronald Reagan."
The fact is that the economy will determine the outcome of this election and most importantly, the perceptions of where the economy is and where it is headed by voters and investors. In a political world of spin perpetrated by the White House where 0.1 point uptick in the unemployment rate is considered "good news" and a meager job creation number- because it is not a negative- is the new "good norm," this country could do and has done better.