Into Perspective: Soft August Flash PMIs

Is the soft landing about to get bumpy? For the past several weeks, economic expectations have inched higher—most notably in the US—as people started fathoming that inflation has eased without central banks inducing recessions. Economists started erasing recession forecasts instead of delaying them. But it seems all it took to reverse the cheer was a bad August for stocks, coupled with some not-so-great Purchasing Managers’ Indexes (PMIs). With these surveys putting Europe in contraction, the US close to flat and only Japan in firm expansion, people once again are arguing recession is a foregone conclusion. We think that is a bit hasty, but sentiment still seems dreary enough toward the weakest spots (Europe and the UK) that an actual downturn should have limited surprise power.

August’s flash (preliminary) PMIs weren’t great by any stretch. Yet this isn’t unprecedented. As Exhibit 1 shows, composite readings (which combine services and manufacturing output) spent much of 2022’s second half (and in some cases beyond) under 50, suggesting more firms contracted than grew. Outside Germany, however, this didn’t translate to a recession. GDP wobbled a tad in Japan, the eurozone and some member states, but it kept growing in the US and to a lesser extent the UK. Therefore, we think it is premature to declare recession is a sure thing now. It may be. It may not be.

Exhibit 1: A Composite PMI Double Dip

Source: FactSet and S&P Global, as of 8/23/2023.

The points in favor of a recession are probably obvious: Those sub-50 readings mean a majority of businesses are reporting a contraction. But there are also counterpoints. For one, PMIs measure growth’s breadth but not its magnitude. So if the minority of firms that reported growth notched a big enough expansion to outweigh the contracting majority, then output could still grow. As noted earlier this week, this is the current trend in US manufacturing, and a similar trend is underway in the UK. In both places, manufacturing output has defied contracting manufacturing PMIs for months. Eurozone output is choppier, but it hasn’t been uniformly in the red since PMIs first notched contraction last summer.

Two, the composite readings could be overweighting manufacturing. Exhibits 2 and 3 break manufacturing and services out separately. As Exhibit 2 shows, with a couple of exceptions, manufacturing has been in the red for a year. This isn’t good, but manufacturing is a small piece of developed-world economies. Even in Germany, widely considered an industrial powerhouse, manufacturing is just 18% of GDP.^[i] Services generates the lion’s share of output, and it isn’t contracting across the board. The US and Japan’s services sectors remain above 50—signaling expansion—while Germany, the UK and the eurozone only just slipped below. Only French services have contracted for more than a month.

Exhibit 2: Manufacturing PMIs

Source: FactSet and S&P Global, as of 8/23/2023.

Exhibit 3: Services PMIs

Source: FactSet and S&P Global, as of 8/23/2023.

If services’ multi-month contraction last year didn’t correspond with recessions outside Germany, we think it seems quite bizarre to equate August’s falling PMIs with broad economic trouble now. Blips have happened before, and this could be another. And if not? We daresay economic fears have lingered long enough to keep surprise power at a minimum. Yes, we had an awful lot of soft landing chatter in the US, but nascent cheer here was an outlier. In the UK, economists remained preoccupied with rising living costs, BoE rate hikes and a perceived lack of meaningful domestic growth drivers. Eurozone concerns are similar, with an added dose of renewed energy jitters. No one did a victory lap when Germany’s contraction paused and eurozone growth resumed in Q2. The reaction there was classic early bull market: Just wait, the real trouble lies ahead. To us, it suggests a continued downturn would mostly just meet dreary expectations, while eking out growth would probably be a positive surprise.

None of this precludes further stock market volatility, which we know is an unpleasant prospect with global stocks down about -5% from their year-to-date high before Wednesday’s rally. Pullbacks and even full-fledged corrections (sharp, sentiment-fueled drops of about -10% to -20%) have happened in bull markets’ first years before. Sometimes weak economic data spur that reaction. Sometimes not. Regardless of the cause, enduring short-term wobbles is part of the price we all pay to achieve stocks’ long-term returns. These wobbles also begin and end when people least expect it, making gritting your teeth and toughing it out the only realistic option, in our view.