Personal Wealth Management / Economics
What PMI Pessimism Likely Says About Shares
It suggests to us global markets are on fine footing.
âThe September PMI data will add to worries that the UK economy is heading towards a bout of âstagflation.ââ[i] Across the English Channel, commentators we follow bemoaned that âthe Delta variant of coronavirus hit demand and supply-chain constraints pushed input costs to a more than two-decade high.â[ii] Japanâs results allegedly âunderscor[ed] the protracted impact of the coronavirus pandemic,â whilst Americaâs supposedly showed âpersistent supply-chain problems hit activity.â[iii] Reading those takes on Septemberâs flash purchasing managersâ indexes (PMIs, preliminary business surveys tallying the breadth of economic growth that are based on 85% â 90% of the final surveyâs responses), you might think these data point to contraction in many parts of the developed world. But if so, that isnât what the data show, as we will explain. Why the dour reaction, and what should investors make of it? Here we help put commentatorsâ latest PMI pronouncements into perspective.
Septemberâs flash PMIs did broadly tick down from August. (Exhibit 1) But all remain well above 50, signalling expansionâexcept Japanâs, which hasnât posted an expansionary reading since April (and, before that, January 2020).[iv] So for the US, UK, eurozone, Germany and France, Septemberâs downticks donât imply contractionâthey just suggest growth wasnât quite as broad-based as last monthâs.
Exhibit 1: Major Economy PMIs
Source: FactSet and IHS Markit, as of 24/9/2021.
Services activityâthe lionâs share of developed world GDPâsaw the biggest drops in the eurozone, leading composite levelsâ declines.[v] But this simply follows the USâs path a month prior: America reopened first from lockdowns amongst western nations, enjoyed the post-lockdown surge in economic activity first, and also saw that initial burst fade first.[vi] That pop, which stemmed from unleashing pent-up demand in late spring and early summer, always appeared unlikely to last, in our view. Once people got the initial rush back to shops and restaurants out of their system, it seemed to us they would logically return to a slower pace of life. We think this is the chief force behind the recent PMI downticksâhence, declines from very high levels earlier shouldnât shock.
Manufacturing seemingly held up a bit better, due partly to lengthening supplier delivery times.[vii] Longer supplier delivery times contribute positively to the headline index since, normally, they signal robust demand as producers canât keep up with incoming orders. That is the case now, but respondents also reported there are severe shortages hampering production.[viii] Even stripping that skew out, though, results were still good, in our viewâmanufacturing output subindex levels were in the low 50s (save Japanâs at 48.1).[ix] In other words, despite supply constraints clearly weighing on factories, most PMI surveys suggest output is still expanding, which implies problems remain surmountable.
Demand remained strong outside Japan, too, according to those PMIsâ new orders subcomponents, although that may be less of a positive signal than it would otherwise.[x] Ordinarily we look to new orders as the forward-looking component of PMIs, but for the moment, we donât think they have much predictive power, if any. In theory, todayâs new orders are tomorrowâs production, but supply shortages scramble any foresight they have now, in our view.
For investors, we think many commentatorsâ negative responses to expansionary PMI readings is a sign of sentiment, not fundamentals. PMIs are some of the most widely watched reports out there based on financial publications we follow. Nowadays, so are supply-chain issues, like the much publicised port backups and semiconductor shortages we see covered almost every day as COVID outbreaks and lockdowns plague key global hubs. The same goes for Chinaâs recent electricity shortage and rationing. We think global markets discount such widely available informationâand well-known problemsâin real time. In our view, equitiesâ direction depends on how reality develops against those expectations, not the generally backward-looking news flow itself.
According to our research, prevailing pessimism sets a low expectations bar for reality to clear, so when the economyâs actual path isnât as bad as feared, equities typically benefit. Weaker economic growth neednât be an impediment. Based on our analysis, over the 3 to 30 month timeframe we think markets generally weigh, bottlenecks will likely prove passingâergo economic weakness and price pressures stemming from them likely also prove temporary. We donât think they materially shift the global economyâs longer-term outlook. Besides, slower growth always seemed likely to us post-reopening, a baseline we think equities have long since incorporated. Supply disruptions this year may have added another wrinkle, but in our view, they probably arenât the cause of an economic downturn markets didnât anticipate.
[i] âOutput Growth Slows Further, While Selling Price Inflation Hits Record High,â Staff, IHS Markit, as of 23/9/2021.
[ii] âEuro Zone Business Activity Slowed in Sept, Input Costs Hit Over Two-Decade High,â Staff, Reuters, 23/9/2021.
[iii] âJapanâs Sept Manufacturing Activity Growth Slows - Flash PMI,â Staff, Reuters, 23/9/2021. âUS Economic Activity Slows in September Amid Delta, Supply Shortages - IHS Markit,â Xavier Fontdegloria, Morningstar, 23/9/2021.
[iv] Source: FactSet, as of 27/9/2021. Jibun Bank PMI Composite Sector Output, January 2020 â September 2021.
[v] Source: The World Bank, as of 27/9/2021. Statement based on US, UK, Japanese, eurozone, French and German services industry share of GDP, 2019.
[vi] Source: Federal Reserve Bank of St. Louis, as of 27/9/2021. US GDP, Q2 2020 â Q2 2021.
[vii] Source: IHS Markit, as of 24/9/2021. US, UK, Japan, eurozone, Germany and France flash PMI reports, September 2021.
[viii] Ibid.
[ix] Ibid.
[x] Ibid.
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