Chart of the week: PMI – Presenting a Mediocre Image
Source: Markit, Bloomberg (as of June 2019)
There are many benchmarks, methods and tools investors can use to try to interpret markets. Business surveys, in particular, are a useful monthly indicator of the state of the world, regions and individual countries. The Purchasing Managers’ Index (PMI) is a valuable metric, especially for looking at the manufacturing and services sectors.
The PMI is based on a monthly survey across various industries, and it covers all of their relevant activity such as orders, delivery times, hiring etc. So it provides insight into purchasing managers’ decisions and broader market analysis. Not only do PMIs provide information about current economic trends in manufacturing and services, but they can also act as a forward-looking tool. It may be considered a barometer of a country’s overall economic activity.
Right now, manufacturing PMIs are weak. In most key economies the index is at or under 50, which is the boundary point of expanding/contracting conditions. This is dramatically different from where we were 18 months ago. Why?
One key factor has been the trade war between the US and China. As global trade growth has slowed, so the manufacturing sector has entered a modest recession. A second feature was the effects of past policy tightening in China. This depressed sentiment in firms and created limitations for hiring and investment plans.
This slowdown has fed into weaker corporate profits growth. After double-digit growth during much of 2018, there has been a sharp slowdown. Earnings growth was just above zero in the first quarter of the year. It’s expected that it will be a little different in Q2.
Investors look closely at business surveys to evaluate economic activity – and central banks do too. In the response to the slowdown in several important global economies, central bankers have indicated that they’re likely to cut interest rates this summer and autumn. Quantitative easing may begin again in Europe. Governments in some countries may also deploy fiscal arsenals. All of this would support riskier assets, such as equity, property and higher-yielding bonds. However, investors must look at equity market valuations as much of this good news is already priced in.
Investors ought to be careful when taking PMI as a forward-looking indicator. Its explanatory power can be patchy at times. New order books have some links with profits growth, but not necessarily in the long term. Furthermore, such business surveys find it much more difficult to price in political strains and stresses than the normal, everyday moves in economic activity.
Looking at PMI is just one of many ways to gauge the economy and investment landscape. Business surveys may be a useful way to get a country’s economic pulse, but investors must take a holistic approach when deploying capital. It’s best to look for valuations signals, structural trends and longer-leading indicators, too.
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