Do November PMIs Point to a Downturn?

Whilst many financial publications we monitor hyped the economic takeaways from last week’s Black Friday retail sales, we think investors actually received a much broader and more useful look at the latest developed-world conditions, courtesy of S&P Global’s November flash purchasing managers’ indexes (PMIs).^[i] We don’t think these reports yielded earth-shatteringly new insights, but they did spur a fresh round of recession (a period of contracting economic output) predictions amongst economists we follow. In our view, that reaction provides a sense of where expectations align with reality, which is helpful information for investors.

As Exhibit 1 lays out, November’s preliminary readings mostly improved on October’s final figures. (Results above 50 indicate a majority of respondents expanded whilst sub-50 imply contraction.) Services PMIs for the US, UK and Japan showed expansion whilst their manufacturing counterparts shrank. These nations’ respective composite PMIs (which combine services and manufacturing output) pointed to flat (in the case of Japan and the UK) or modest growth (in the US). The numbers were worse in the eurozone and its two largest economies, Germany and France, as services and manufacturing PMIs remained in contraction.^[ii]

Exhibit 1: The Latest PMIs

Source: FactSet, as of 27/11/2023.

Throughout the publications we follow, many commentators argued the data suggest a broad downturn may be afoot. Some economists we follow extrapolated the eurozone’s November PMI weakness into a Q4 GDP (gross domestic product, a government-produced measure of economic output) dip, which would extend the region’s quarterly contractionary GDP streak.^[iii] We found views aren’t much more optimistic across the English Channel, with observers anticipating sluggish UK growth at best—and elevated recession risks entering 2024. Japan’s sub-50 manufacturing PMI and flat composite prompt chatter of a Japanese technical recession (defined by many as two consecutive quarters of contracting GDP). The US avoided recession speculation this round—but most experts we track project growth decelerating through yearend.

We won’t sugarcoat it: November PMIs weren’t great, and they extend some longer-running trends. Most manufacturing PMIs have been below 50 since mid-2022, and though services PMIs haven’t fared as poorly, they do point to tepid conditions in developed nations’ dominant economic sector.^[iv] Yet we don’t think today’s environment looks radically worse than the recent past. Go back to late 2022. At the time, services PMIs for the US, UK and eurozone showed contraction, with only Japan growing.^[v] Today, US and Japanese services PMIs are expansionary whilst UK and eurozone services PMIs spent most of the past four months in contraction.^[vi]

Exhibit 2: Manufacturing PMIs Over Past Two Years

Source: FactSet, as of 27/11/2023. Manufacturing PMIs for US, UK, eurozone, Germany, France and Japan, November 2021 – November 2023 (flash).

Exhibit 3: Services PMIs Over Past Two Years

Source: FactSet, as of 27/11/2023. Services PMIs for US, UK, eurozone, Germany, France and Japan, November 2021 – November 2023 (flash).

Yet 2022’s mixed PMIs didn’t mean recession in most major developed economies according to our analysis. The US and UK didn’t see recession this year despite late 2022’s PMI contractions. Yes, Germany appears to have been in recession since Q4 2022, as GDP hasn’t grown in three of the past four quarters.^[vii] But other eurozone nations have largely offset to this point, based on our research.

Of course, it is possible—though not inevitable—other nations enter recession, too. New orders, which our research finds are PMIs’ forward-looking component, have struggled in this year’s second half. Eurozone manufacturing new orders and services new business continued contracting, albeit at a slower pace.^[viii] In Japan, new orders growth picked up in services but weakened in manufacturing.^[ix] UK manufacturing new orders fell for a fifth straight month whilst new business for US services firms grew for the first time in four months.^[x] Today’s orders are tomorrow’s production, and with firms reporting tepid demand on this front, we wouldn’t be surprised if many developed economies putter along for the foreseeable future.

That said, PMIs don’t preview GDP—which we think the recent data illustrate. As surveys, they provide a sense of the breadth of growth or contraction—not the magnitude. A majority of surveyed businesses could report contraction, but if the minority of expanding firms grew more than the majority shrank, the net outcome could still be positive. Consider the UK and eurozone. Despite long (and in the case of eurozone manufacturing, ongoing) stretches of PMI contraction—and despite some dips along the way—actual output has held up better than the monthly surveys suggest. (Exhibits 4 – 5)

Exhibit 4: Eurozone Manufacturing and Services Production

Source: Eurostat, as of 28/11/2023. Index of services and index of manufacturing for the eurozone, January 2022 – August 2023 (latest data available).

Exhibit 5: UK Manufacturing and Services Production

Source: Office for National Statistics, as of 28/11/2023. Index of services and index of manufacturing, January 2022 – September 2023.

Whilst we have seen much debate about what PMIs and other economic data mean going forward, they are old news to stocks, in our view. When measured in dollars, global stocks began recovering from last year’s downturn in October 2022 as PMIs weakened across developed economies to end the year.^[xi] We don’t think there is a disconnect. Rather, it seems to us stocks pre-priced the economic weakness and began looking ahead. That doesn’t mean stocks require the global economy to be firing on all cylinders to do well from here, in our view. What matters more, based on our understanding of markets, is the gap between expectations and reality. Last year, we observed many outfits were forecasting recession—with a deep one in the eurozone. Those dire forecasts didn’t manifest, which we think delivered stock markets relief—a positive surprise. According to our research, that is often enough to buoy stocks in a young bull market, and with sentiment still dour, that seems likely to persist.