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Monday 3 December 2012

GLOBAL ECONOMY (December 3rd 2012): Global PMI Round-up; ISM Below 50 Again, China Bottom?



Today saw the final Manufacturing PMI reports to be released in 2012 from Europe to China and the USA.


We focus on the trend in PMI statistics from around the world, to serve as an accurate bellwether for trends in business conditions and economic activity. While market timing can be a difficult, if not impossible task, trends in leading indicators are an important factor in estimating periods of economic strength or weakness. These trends, in turn, helps us analyse the current stage of the business cycle, and other factors affecting equity markets - often before earnings, or the stock market, fully appreciates the trend.


Before we look at today's PMI releases, what did last month's reports tell us? What questions should we be asking today?



  • China PMI data has indicated, in recent months, that the "China slowdown" theme could be over. Both HSBC and Official PMI figures have troughed, and last month made an eight month high. With the Chinese stock market still near multi-year lows, more convincing evidence of this trend in December could present a stellar opportunity to add long exposure in the region. Is the recovery for real, or a blip in a multi-year slowdown?
  • The US economy seems to have also bounced back from its Q3 malaise, despite ongoing concerns over the fiscal cliff, which pushed equity markets lower last month. In this sense, we feel vindicated (so far) in our call to increase equity exposure on oversold November conditions. In 2012's final ISM Manufacturing PMI report, will the recovery trend continue into 2013?
  • Our biggest concern last month was the setback in the recovery of Eurozone PMIs, with the French manufacturing sector indicating steep contraction, and recoveries in German, Spanish and Italian data all stuttering. In recent years, the market has been very sensitive to PMI divergence in this region - most recently from March onwards until the summer. Handed a more reasonable Euro-Dollar conversion rate in November, will the recovery trend get back on track? Or is Europe about to swamp our headlines yet again?
  • Japanese PMI represented a significant concern last month, hitting a fresh 18-month low. While rarely a useful global bellwether, the Japanese economy is still huge - we generally want to see all our major economies improving together. If the Yen "needs" to devalue, is there an opportunity in the currency markets against the dollar? Will the Japanese PMI recover this month or hit fresh new lows?


You can read our full analysis of last month's PMI reports here.




United States of America - The big news today was ISM Manufacturing PMI slipping back into contraction, falling to the lowest level since July 2009. The headline index fell from 51.7 to 49.5. This was in contrast to Markit's version of US Manufacturing PMI, which climbed to the highest level since June, from 51.0 to 52.8.



Charts courtesy of the excellent Forex Factory

This lends itself towards a variety of different interpretations - sadly it is difficult to draw strong conclusions, other than to say that the second half of 2012 has been generally poor for the US manufacturing sector. We had hoped the September and October PMI reports would provide signs of an improvement in business conditions going into 2013, as QE3 filtered into the wider US economy.


However, the effects of Hurricane Sandy and uncertainty over the US Presidential Election/fiscal cliff have seemingly provided another setback in that recovery. 

Nevertheless, we are inclined to believe that these kinds of temporary drags on business confidence can be resolved - and that delayed demand may present itself in improved figures in Q1 2013. While we never try to second-guess the data, it would be foolish to ignore obvious factors causing near-term data to be subdued. If the fiscal cliff is not avoided, and business confidence takes another serious hit in Q1 2013, then there would be more cause for concern.


With QE3 and by extension a sustained recovery in the US Housing market underway, we'd rather take a neutral rather than bearish view on this trend - anyone taking advantage of entry prices on US indices on oversold November conditions (1340-60 on SPX, 12500-12600 on Dow) can probably let the position run into the New Year. At 1400/13000, no exciting possibilities jump out for new entries, until the fiscal cliff is resolved or data improves.




China - improved for third month in a row, to a nine month high posting 50.5 up from 49.5. That's the first expansionary reading since 2011. The official "China Federation of Logistics and Purchasing" version hit a seven month high, having also troughed in Q3, posting 50.6 (up from 50.2).


Last month we claimed we'd have more faith in the recovery in China PMI data if it was confirmed this month - it has delivered, indicating perhaps the end of deterioration in Chinese business conditions, a considerable drag on the 2012 global economy.

This should not constitute a blind buy recommendation for stocks in that region - that is only one of many ways a trader or investor might approach this move towards improving business conditions in China. For one, our overall global macroeconomic outlook looks far brighter without China "slowing down".





As we can see, the recovery remains fragile, and this wouldn't be the first false start if conditions deteriorated into 2013. However, until proven otherwise, we have reasonable grounds to believe from the data that an improvement is underway in business conditions.

Presently, the Shanghai (SSEC) equity market index sits on a price to current (2012) earnings ratio of around 10.7 . If as an investor you are bullish on China's long term prospects, and you feel that 2012's earnings are a safe, conservative level to rely upon, then this may be a fine opportunity to add long term holdings. Shorter term traders may have to time their entry to their preferred method - it takes some bravery to add exposure near bear market lows.





Japan - Another month of considerable deterioration in Japanese manufacturing business conditions, as PMI falls to new multi-year lows, from 46.9 to 46.5.




You can find our criticism of Japanese PMI as a global bellwether in previous posts, or in the summary of last month's report above. However, when we see such strong divergence from the global economy taking place in Japan, it makes us nervous for repercussions in the rest of the world - lest we forget it remains one of the largest economies on Earth.

Rather like in the UK's indicators, we find it difficult to apply this kind of analysis to the Japanese stock market - for instance, by short-selling the NIKKEI. Instead, we wonder what currency implications might be for the Yen - already almost 5% devalued against the dollar since November's high. If this bearish trend continues, where will the Yen be against the dollar several months from now?

Looking at the internals of the report, panellists suggested a lack of business confidence was causing capital investment to be postponed. Panellists also suggested that with an overhang of input supplies (due to lack of demand), competitive pressures, and clients demanding discounts, manufacturers in capital goods sectors were forced to lower their prices.


Spain - moved back towards recovery this month, with PMI increasing to highs unseen since August 2011 by posting 45.3, up from 43.5 last month. The Spanish manufacturing sector may still be in deep contraction, but in any depressed situation, a recovery trend is extremely significant. Especially when that economy has been at the epicentre of the global market's fear since 2010, and when that PMI is so closely correlated to the market's attitude toward the Eurozone.




Last month, one of our major concerns was the setback in PMI improvement seen from the Spanish economy since the summer. By improving to new highs this month, we have renewed confidence in Spanish business conditions bottoming in 2013, so long as that recovery trend continues. Whether peripheral Europe can continue to improve if the Euro appreciates, might prove an important test next year.




Digging deeper into the internal components of the report, a lack of domestic demand was cited as a drag on overall performance, while international new orders remained stable compared to last month (where export orders had started to improve). Price discounting to remain competitive was reported as a driver of that, while the opposite approach was taken in Italy, as we mention below...




Italy - declined for the second month to 45.1 from 45.5, in contrast to Spain. Both peripheral European countries, taken on a spapshot of this month's conditions, are suffering deep contractions in their manufacturing sector. Most disappointing for Italy however, is the extent to which conditions have not improved since the summer, or since 2011 in general.




While Italian Manufacturing PMI has moved away from the lows of another depressed summer, the chart clearly shows the stagnation, or lack of improvement trend, in Italian business conditions. In the same sense as last month, there are no real positive conclusions to draw - other than disappointment in the larger trend, and relief that conditions haven't deteriorated further since the summer.

The internals of the report directly suggest weakness from French and German clients, reported by panellists. New intake of business was recorded as low, with backlogs of work being eaten into at the sharpest rate since the summer. Disappointingly, after progress was made in October on new international business, this component worsened this month, making for an overall disappointing report. The commentary directly questions the competitiveness of Italian manufacturers at these prices, amidst costs being modestly passed onto clients this month, perhaps causing more business to be lost.

 

France - increased to 44.5 from 43.7, and 42.7 in the September report. While we are pleased that this indicator has made two months of solid improvement, we also understand that this is a volatile indicator from one month to the next.




This chart shows the early flash reading of French Manufacturing PMI, but the results are similar to the final reading. Given the evident volatility, peaks and troughs are less useful to observe as they occur in real-time. Instead, we can tell that on average, business conditions have been getting progressively worse in France since 2011. Even after two months of improvement in PMI, at 44.5, the manufacturing sector continues to deteriorate.


Worryingly, this month reports that output had fallen in response to falling new orders, and much production came as a result of the devouring of backlogs of work, at a pace unchanged from October. The commentary suggests a lack of domestic demand, and the retrenchment of French manufacturing on a whole, responding to the expectation of weak demand for the foreseeable future.

We'll be more convinced of a recovery in French business conditions if the data significantly improves into 2013. Until then, we're not entirely sold on the French economy.





Germany - increasing to 46.8 in November, up from 46.0 in October. This was another recovering Eurozone PMI to suffer a setback last month - we're pleased that German business conditions took a positive step towards continuing that recovery in this month's report.





The general trend of improvement since the summer is slightly more obvious than in the French statistics. While the German manufacturing sector remains in contraction, the present data suggests a mild trend of improvement, that will hopefully see the sector return to expansion in 2013. Unquestionably, in the December report released early next year, we will want to see a reading closer to 48.0 for proof that the trend is not stalling. Supporting this, new orders and production components of this month's report stabilised close to 50, for the first time in several months.


A telling note in the article mentions "Some firms noted that an improved demand in China had helped offset a continued reduction in new orders from clients within the Euro area."



Eurozone Composite Manufacturing PMI - returned to its trend of improvement this month, hitting an eight month high of 46.2, up from 45.4, the Eurozone's 16th consecutive month of manufacturing contraction.



We can see that conditions remain at depressed levels, but can take encouragement in the signs of improvement since the summer. Last month's setback was a worrying sign for global markets, given the accuracy of Eurozone PMI in predicting market trends. Hitting an eight month high this month, we hope the data continues to improve more convincingly into 2013.


 

Miscellaneous - Russian PMI declined slightly to 52.3 from 52.9, but has remained remarkably robust throught 2012. UK Manufacturing PMI rose to a three month high, from 47.3 to 49.1, but still demonstrating virtually no trend in the data. Brazil Manufacturing PMI jumped higher from 50.2 in October to 52.2 this month, citing a surge in production and new order volumes. 





JP Morgan Global Manufacturing PMI - rose sharply to a five month high to 49.7 in November from 48.8 in October. As we wrote last month, "This is a very smooth, composite indicator for the whole world, with PMIs weighted by economic influence on global GDP." You can read this very useful report here.

We note that this formula now uses Markit's own US PMI, which is more complimentary of the US manufacturing sector this month. The JPM Global Manufacturing PMI helps us keep in perspective the importance of certain economies over others in terms of global GDP - placing more weight in the importance of the improving Chinese and deteriorating Japanese PMI data for example.

Generally new orders and output were said to be improved on the previous month globally, in both cases moving back towards stabilisation. In export business however, divergence was clear between Japan/Europe and the US/China, as we've seen in the above reports.




OUR CONCLUSIONS

Once again we're presented with a mixed bag this month in terms of trends within PMI statistics.

  • China has shown more convincing evidence that business conditions have stopped deteriorating, allowing for hope that we can count on China in 2013 for stable growth. While the recovery in data is fragile, at a nine month high, we're more convinced than before that the Chinese economy has "stopped slowing".
  • The US economy continues to slip and stumble as it attempts to navigate upcoming fiscal uncertainty, pouring cold water on the theory that a positive trend was developing into 2013. We still wait for signs that QE3 or improvements in the Housing sector will trickle into the rest of the US economy.
  • The deterioration of Japanese business conditions continued again this month, an under-reported concern for the global economy. Most worrying perhaps is the suggestion that a complete lack of demand and business confidence has reduced capital investment this year, further compounding the problem.
  • Europe has answered some of the concerns from last month - particularly in the Spanish and German data, where recovery trends have continued. The region remains a mixed bag however, with Italian and French reports doing little to encourage investors. On a whole, the region saw an improvement this month, while remaining in worrisome contraction.





AND THE IMPLICATIONS FOR INVESTORS?

Like last month, we begin this one with US equity markets hovering around equilibrium, at around 13000 on the Dow.

If you chose to add to positions on oversold November conditions as prescribed in our previous articles, you may have a different disposition to the market at these levels, sitting on a comfortable profit. If that is the case, you may be happy to hold onto those bullish positions heading into the new year, with a comfortable margin.

However, we won't be looking to add new US positions with any particular bullish or bearish bias, while the market remains around 13k. With ISM back into contractionary territory, and hopes dashed of a sustained improvement is US conditions, we don't see much point in being overly active in this region unless an attractive opportunity is presented in the strongest sector - US Housing.

The problems in Japan may stretch further than a currency problem, but a more competitive Yen would surely improve the prospects of Japanese manufacturers. A trader with experience in Forex may wish to evaluate the possibilities of even further declines in the Yen against currencies in more competitive regions.

Longer term investors meanwhile may want to investigate possibilities in stocks with Chinese exposure, or more directly through China investment funds. While we cannot be certain that conditions in China are "bottoming", we know that on a 10.7 multiple of 2012 earnings, long term China bulls could enjoy a relative margin of safety so long as 7-10 year growth in Chinese earnings is at least modest, compared to 2012 levels.

The uses of PMI report data are vast and numerous for traders and investors. While we can suggest areas that an investor may want to consider, ultimately there are thousands of possible meanings to take from a single month's reports. In the case of Global Manufacturing PMI this month, we can at least be content that 2012 will close with several large economies stabilising as we enter 2013.



Saturday 10 November 2012

US MARKET ANALYSIS (November 10th 2012): Prevailing Bearish Sentiment in Market Breadth

Just a quick post this weekend to highlight the technical weakness in US market breadth, which has deteriorated over the last month or so.

As we highlighted last week, leading economic indicators were broadly disappointing for the month of October. While encouraging signs were made in the recovery of US indicators, and there were some early signs of a "bottoming out" of Chinese leading indicators, the signs from Europe and Japan were cause for concern. Sure enough, this was highlighted by comments made by Mario Draghi this week, which put pressure on global equity markets.

We concluded our article last week with the following:

How does this month's data relate to our investment decisions in equity markets? While it is difficult to say where technical momentum will carry US indices, we may be more inclined to eventually buy oversold conditions in select industries, even after some disappointing PMIs this month.... There are greater apparent risks to the recovery trend than last month, especially emanating from Europe. As ever, it is worth being highly selective in entering positions, with a healthy appreciation of the risks - only adding to positions if it becomes clearer that there is positive momentum in the US economy.

I'd like to build on the statements made in that article. If we are selective with the markets and industries we wish to buy into, is now the right time to be buying on weakness before the end of the year?

While we might be inclined to eventually add risk, it is ultimately hard to decide how technical momentum will affect the entry-points we are offered as investors. One useful method is to judge the market's prevailing mood with analysis of market breadth.

For brevity, you can read more about the individual indicators and their calculation at www.stockcharts.com, where these charts are taken from.


BULLISH PERCENTAGE INDICATORS






We commented on our use of the Bullish Percentage indicators in early October:

This brings us to our crossroads point in October 2012. The BPNYA hasn't made a new high in a couple of weeks, and since mid-September has been consolidating. In 2011 and earlier this year, BPNYA spent 9-10 weeks consolidating in this way - making new Dow/S&P highs in the process - before diverging from the market and falling. We will continue to watch the market breadth indicators for developments as it remains in this consolidation phase. If it begins to fall violently, diverges from the market, or continuously fails to make new highs along with the market, we will begin to take profits on long exposure.

The chart above shows how BPNYA has developed since then. The period of consolidation has been followed by a loss of momentum and eventual declines. Failure to make new higher highs in the Bullish Percentage indicators can signal a change in mood of the market. While this indicator has no regard for levels the market could fall to, we know that these indicators are reflecting a bearish mood in the main US indices.

In other words, from mid-October onwards, the bullish percentage indicators have independently given us reason to worry about a significant market sell-off. In these kind of conditions, we want to be more patient in waiting for opportunities to buy oversold markets. Like August-October 2011, it can be highly risky to buy on slight pullbacks when the market's mood is bearish.



PERCENTAGE OF STOCKS ABOVE THEIR 50MA AND 200MA


This is a new indicator for us to discuss at Big Macro Picture. It is more volatile than the Bullish Percentage, which rely on Point & Figure analysis. It's a very simple measure - how many stocks in the S&P or the whole NYSE are above or below their 200MA? How about their 50MA? And how is that changing over time?





The trends in both charts, the % of stocks above their 200MA on the S&P and NYSE respectively, are quite clear. We can see the medium term trends in the market on a whole. From warning us out of the market in March 2011, to guiding us back in after October, the results last year were impressive. By helping us identify a weakening trend in April 2012, a difficult couple of months could have been avoided. Changing direction in June, and again in September, identifies two more turning points for the market this year.


The trend and direction of this indicator is fairly slow and deliberate, but certainly has leading qualities for the main US indices. An opportunity may eventually be afforded to the smart investor who pays attention to this indicator troughing, whenever that may be, and wherever the market is by then.

Below we have the 50MA version, which as you can imagine is far more sensitive.

  
 
As you can see, this measure looks far more erratic in candlestick form. Using the momentum indicator below can often be more useful than the 20 week MA in this case. We can see a clear early signal to re-enter the market in September 2011 - another early warning signal to reduce risk in March 2012, a re-entry signal after the weakness in June 2012, and an early signal to reduce risk again in early October.

The trends, peaks, troughs and cycles in all four charts are useful in determining underlying market sentiment. All four have deteriorated rapidly in recent weeks - we wait for signs of consolidation.



CUMULATIVE NYSE ADVANCE-DECLINE ISSUES


This indicator is unlike any other I tend to use, and is a cumulative calculation of advancers vs decliners over time on the NYSE. It can be a useful long term indicator, and tends to have very broad multi-year trends.




Again we can use a simple moving average (in this case 13 week MA) or a momentum indicator to define the different modes and trends in the underlying indicator. We can compare the results from other indicators to 2011 and 2012 so far. June-October 2011 is identified as a time to avoid being over-exposed to the market. October 2011 - April 2012 is identified as a "risk on" period. May 2012 is identified as a period of market weakness, but very quickly rebounds throughout the summer.

Now we see the most recent cross-over in late October, for both the TSI (bottom) and the 13 week moving average. This indicator is broad and rarely the most sensitive to react to changes in market sentiment, but recent weakness in this indicator is a cause for concern.


Another indicator, the McClellan summation index for the NYSE, is similarly used to measure the net advancers vs decliners in US stocks, and reaches very similar conclusions.


We can see this in the recent declines below the 20 week moving average, and cross-over in the True Strength Index. You can read more about these indicators here.


 

NYSE HIGH-LOW INDEX

Finally we'll consider the NYSE Hi-Lo Index, a smoothed indicator showing trends in the number of NYSE stocks making new highs or lows. This is a particularly choppy indicator even after smoothing, so we use a slower form of TSI (40,20,10) settings, and rarely use the 20 week moving average for signals.


We can see how choppy this indicator can be - but also how market phases can be determined using the TSI. We can see how an early risk-off signal was given in April, and how the decline in NYHILO halted before the market lows in June. The TSI, having moved positive again in July, has crossed back to negative this week - inferring a very different mood in the overall market.



CONCLUSIONS

We have seen a variety of different market breadth indicators signalling a new prevailing mood within the stock market, beginning with the peaking of many measures of market breadth between September and October. With the advent of this week's sell off, the TSI momentum indicators have crossed over in each instance.

This shouldn't be taken as an outright signal to be net short in equities. Rather, it is an indication that we might be best served waiting before "buying weakness" in even the strongest sectors of the US market.

The analysis regarding leading indicators from last week still remains valid - the US remains the strongest main market, while Japan and Europe have particularly worrisome trends in PMI. While the US seems to be enjoying a sustained recovery from the summer's economic malaise, the above indicators show that we should be careful in our market timing.

Until we see a sustained improvement in these indicators, and with emphasis on the fragile nature of the recovery in the global economy, we'd wait before being too greedy amidst the fear prevalent in the market.

In short, "eventually buying oversold conditions" might still take a little longer. Hopefully we'll see more bullish evidence in the US economy before then.



Sunday 4 November 2012

GLOBAL ECONOMY (November 4th 2012): Global PMI Round-up; How Strong Is the "Improving" Trend in Economic Data Worldwide?


Thursday and Friday this week saw the release of important economic reports from the United States and the rest of the world. ISM Manufacturing, Non Farm Payrolls, Unemployment Claims and PMI stats were released for October - with important implications for the imminent US Presidential Election, ongoing global monetary policy and overall trends in the global economy.

In this article, we'll build on last month's analysis and provide a review of the world's PMI Reports, courtesy of Markit, ISM, HSBC and JP Morgan. You can see most reports for yourself here.


LAST MONTH'S REPORTS

You may remember from last month's article here, that the last round of figures were broadly improving - China saw a modest improvement in operating conditions, Japan hit a three month high, Russian PMI made a four month high, Spain improved slightly, Italy saw a six month high, Germany saw a marked improvement despite still being in contractionary territory, and the Eurozone Composite hit a six month high.

The US saw mixed figures pointing to fairly mediocre growth, but an arrest in the decline seen over the summer, and a move away from contraction in ISM.

France and the UK meanwhile saw disappointing figures.

This left us waiting for more convincing confirmation of a recovery in leading indicators, but with a sense that we'd seen a definite stabilisation since the summer. We felt the market meanwhile had been "guessing" on QE3 improving the data from June onwards, and preached caution of chasing risk as the market hit multi-year highs. Purely in terms of data however, the September reports were positive. Would October build on that burgeoning trend of recovery, or would we still be left waiting for monetary policy to filter into business conditions? If so, how patient can the market be?


GLOBAL PMI ROUND-UP FOR THIS MONTH


Let's look at the same major economies we covered in the September reports.


China - posted 49.5 in October, up considerably to an eight month high from 47.9 in September, and 47.6 in August. To better explain the trend in Chinese PMI (both the more "official" and HSBC versions), I've provided the charts below.

All charts courtesy of the superb ForexFactory

The HSBC version more accurately depicts the malaise since the "China slowdown" theme became apparent. The "China Federation of Logistics and Purchasing" version meanwhile seems to be more sensitive to the month-to-month swings in global business conditions. While we're keen to applaud the trend of improvement in the last couple of months in both versions, as both charts show, there is far from a clear sign that China has "bottomed" in the data. Especially while the HSBC version remains in this multi-year contraction.

What do the report internals say, to maybe give us more hope for this little recovery? Encouragingly, for the first time in 12 months New Orders moved into positive territory, citing a growth in new clients. This offset a sixth month of decline in New Export Orders, as demand remains weak in the US and Europe. The commentary suggests that the deterioration may finally be over in China, and that easing measures are finally filtering through into business conditions, at a pivotal time in Chinese politics.

At Big Macro Picture, we'll believe it when the trend in data improves more convincingly, but this is definitely a positive month for Chinese PMI.




Japan - sank to eighteen month low of 46.9 in October, down from 48.0 in September. While last month's report was a moderate improvement, the chart below shows the generally depressed nature of Japanese PMI since the summer.




We're not big fans of Japanese PMI as a global indicator, but it is worth taking their report into consideration for the big global picture, even if Japanese PMI rarely acts as a useful bellwether. The internals of the report suggest sluggish international demand, excess capacity, and a reduced purchasing appetite amongst managers. Like our analysis of the UK, a healthy appreciation of currency-related issues has to factor into our thinking - for instance, how much weaker has the Euro or Dollar become in relation to the Yen? And how has that affected, as cited in the report, weak car exports? The report overall is disappointing and even forgiving currency-related weakness, detracts from the argument that PMIs are in recovery.


Russia - extended its impressive run to a five-month high of 52.9 in October. As mentioned last month, we do not often draw global conclusions from Russian PMI - however, the internal commentary of the report is interesting. While new export orders suffer from weak global demand, the resilience of the domestic Russian economy is cited, along with private consumption growth to fuel the production of consumer goods. Like last month, Russia is serving to contribute to the "positive" argument for PMI recovery since the summer.


Spain - declined from 44.5 to 43.5. As we mentioned last month, and as we can also see on the chart below, Spanish PMI is a very smooth and relevant leading indicator. It captures the marginal month-to-month changes in the peripheral European economy, and as it stands at the epicentre of the "European debt crisis", garners much attention from the market itself.



When such a smooth indicator stops recovering and posts a three month low, it is worth taking note - especially when it formed one of the most compelling bullish PMI arguments from August onwards. While the Spanish PMI has been in heavy contraction since 2011, as we saw in 2009, there is a large difference between a "recovering PMI" below 50 and a stagnating one, where markets are concerned. Analysts will hope that this decline is a blip in the recovery from August onwards. Internally, based on falling new orders and output components, as well as reductions in "prices charged", we might worry that there could be more weakness to come. This is certainly an indicator worth following as we go into 2013.


Italy - declined marginally from a six month high of 45.7 in September, to 45.5. While this may sound bad, and is far from good news, we are still far from the lows of the summer in Italian PMI, after it jumped higher last month.


As we said last month, there isn't much of a "recovery trend" to speak of in Italian PMI, but such a marginal decline probably does not invalidate the improvement since August. Interestingly, something that was also reflected in the Spanish report, New Export Orders saw an improvement in trend - turning positive in Italy. However, domestic demand was cited as a major drag on both economies, as margins continued to be squeezed for Italian producers. In terms of our big picture, the "recovery trend" or lack thereof in Italian PMI is neutral to any bullish or bearish arguments this month, and really continues to stagnate around the 2012 average.



France - recorded 43.7, only a slight rebound from 42.7 in September, which was the worst reading since April 2009. French producers continue to eat into outstanding business, and excess capacity is growing noticeably. Low demand and low business investment/confidence are cited as significant drags within the domestic market. New Orders were barely improved from the three-year lows seen in September, and new export orders were the worst since mid-2009. The report concludes by suggesting a return to recession in France is a major risk before 2013. This is a significant concern for France, as leading indicators for the last two months have pointed towards severe contraction in the manufacturing sector. Despite rebounding slightly this month, the negative trend in French PMI remains one of the most bearish factors in our analysis of European leading indicators.


Germany - 46.0, a sharp fall in PMI from 47.4 last month, but still some way off the 2012 lows. Subdued business confidence was considered a major factor in the ongoing contraction, while backlogs of work were eaten into at a sharp pace as new business and demand remained depressed. In terms of analysing the trend in German PMI, it is disappointing that this indicator did not continue to build on the improvement seen last month. However, as it is some way off the lows for 2012, it cannot be considered part of a convincing trend as a result of this disappointing report. Simply, we note that it is not alone this month in failing to post a "higher high" within any supposed recovery.


UK - lower again this month, from 48.1 to 47.5. As the chart below shows, UK PMI can be a "messy" indicator to deal with nowadays, and is often difficult to use as a bellwether for global economic conditions. 



Like many other indicators, UK PMI seems to have peaked in February-April and troughed in August for 2012. While the last three months show a worrying continuation of the 2012 malaise, it is difficult to derive much of a declining trend from these reports. Internally, the report shows another sharp decline in New Export Orders - showing weak demand in Asia and mainland Europe, and probably not helped by the strength in Sterling. One interesting note, as was reflected in the German report, manufacturing in the consumer goods sector rebounded impressively this month, possibly reflecting an improvement in global retail sales and the international consumer.



Eurozone Composite - 45.4 in October, ticking down from September's six-month high of 46.1. As mentioned last month, this broad indicator tends to give us a smooth representation of the Eurozone as a whole, from the periphery to the core. Apart from economies we have already covered, this report mentions Greek PMI at a four month low, Austrian PMI at a 40 month low, the Netherlands at a three month low, and Ireland at a three month high. Every economy covered by the composite report, other than Ireland, is showing contraction in PMI.




Being a smooth, composite indicator, we tend to take notice when this indicator trends in one direction or the other, especially given its relevance in 2012. It is not immune to producing "off trend" reports which turn out to be anomalies in a wider trend - so we're not worried by one single bad report. However, it is probably indicative of how fragile this recovery in the data has been since the summer - if it will be remembered as a true recovery at all.

We can see on the same chart how much conviction there was behind the strong rebound in business conditions in 2009, with almost a straight year of month-by-month improvements in PMI. While not every trend can be as smooth or convincing as that, a step closer to expansion this month would've given us more confidence that business conditions were on the right track in the Eurozone - instead, one of our bullish arguments has become more doubtful.



United States of America - ISM Manufacturing PMI shows another month of improvement from 51.5 to 51.7 in October. Again, this is best shown on a chart, lest we forget that we are barely 1 percentage point off the 2012 lows in this indicator, and barely in "growth" territory.




However, one of the most encouraging signs this month has been another better than expected (and improving) ISM PMI, one of our favourite leading indicators. After dropping unexpectedly in mid-2010 and mid-2011, ISM stabilised over six months or so, and then began beating expectations and modestly recovering (periods of impressive returns for equities).

Naturally we're pleased that ISM has seemingly troughed for 2012 (if you believe this is a trend of recovery) and has made two month's worth of higher highs. However as we noted last month, equity markets began reflecting this kind of improvement all the way back in June, on the expectation that QE3 was imminent - so investors cannot really use this as "divergence" to justify adding equity market risk.

Another side of the story comes from the less established US Markit PMI. This version of US PMI edged slightly lower to 51.0 from 51.1, the lowest reading since October 2009. Both New Orders and New Export Orders components declined - and without seasonal adjustments, this version of PMI moved close to contraction for the first time since the bull market began.

Output on a whole increased at at a faster pace, but interestingly - a theme we've seen throughout these reports - the rise was solely down to the reported increase in consumer goods production. Output of investment and intermediate goods actually declined.


Both versions of PMI reflect a barely-growing US manufacturing sector, fraught with insecurity in the new orders component, perhaps due to fiscal uncertainty. While ISM shows a US economy stabilising and improving from the summer, the Markit version continues to reflect deteriorating conditions in 2012.


To muddy the waters further, as a "stronghold" of the global economy in 2012, US PMIs have held up remarkably well compared to the rest of the world. With peripheral Europe at the centre of ongoing concerns, it has sometimes taken three or four months to "drag the US down" when the European leading indicators have taken a downturn. This makes it more difficult to use the US economy as a leading "bellwether" for global conditions, even though the US economy is the single most influential factor in the global business environment.

Being such an influential component, we can take ISM's stabilisation and improvement as an important indicator that the world's largest economy is out of the summer doldrums - albeit in a very fragile state. This is also reflected in Non Farm Payrolls, something we'll discuss in an article later this week. Markit's version, meanwhile, continues to give us something to worry about. Questions such as "when will QE3 filter into the data more convincingly" and "what will be the effect of the devastating Hurricane Sandy on the US economy?" remain unanswered, something we'll need to look out for in next month's reports.







Miscellaneous - there are a number of economies we do not tend to cover in detail in our PMI analysis, either because of poor "leading" performance as an indicator, or to avoid even longer articles. Briefly then, Canadian PMI fell from 52.4 to 51.4, Brazil PMI moved back into expansion from 49.8 to 50.2, Indian PMI was broadly unchanged near the lows of 2012, Mexican PMI (seemingly a lagging indicator) moved from 54.4 to 55.5,  South Korean PMI rebounded from 43-month lows to 47.4 from 45.7 and Australian PMI edged higher to 45.2 from 44.1.



JPM Global PMI - rose for the second month, from 48.8 to 49.2. This is a very smooth, composite indicator for the whole world, with PMIs weighted by economic influence on global GDP. You can read this very useful report here.

This rise may seem surprising, considering the declines reported in Japan and the poor showings in the UK and Eurozone. Certainly the breadth of this month's report is questionable, with the likes of France and South Korea only rebounding from a very low base, and only the the US ISM showing much conviction in a recovery trend from the summer.

Nevertheless, it is useful to note that this indicator has moved off it's 2012 lows, even if it is too broad to capture ongoing conditions in the beleaguered Eurozone. Improvements in the US and China this month cannot be ignored given their influence on the global economy - and the rest of the world may find themselves relying on their strength as we enter 2013.




OUR CONCLUSIONS

With this latest round of data, our perception of the strength of the MEDIUM TERM "recovery" trend has changed somewhat, while we still wait for more convincing signs that global monetary policy is improving business conditions.

Despite the disappointments and setbacks this month, PMIs have mostly troughed and recovered from the summer lows, as we reported last month. The number of PMI reports issuing new multi-year lows are now few, while many are only one month from trend highs. However, the strength or "conviction" in that bullish recovery trend is more doubtful after so many key economies fell back from last month - namely in the Eurozone and Japan.

The recovery trend in ISM, and the eight month high in Chinese PMI, represent the highlights from this month's data, from perhaps the two most influential economies in the world. In both cases, easing measures are filtering into the wider economy, with momentum which we would hope to see continue into 2013. However, with political and fiscal uncertainty surrounding both countries - not to mention the tragic consequences of Hurricane Sandy in the States - the fragility of both recoveries remain in question.

Perhaps the most disappointing aspect of this month's data comes from Europe, particularly the setbacks in Italy, Spain and Germany, where previously the data had been recovering. The UK data saw another month of decline, while France rebounded from a low base, still far below its 2012 average. Greece, the Netherlands and Austria all moved lower. It would be wrong to suggest that this month's data is pointing to a new bearish trend, but it pours cold water on the idea of a strong recovery from the summer's lows. 

The strengthening of the Euro against the dollar in recent months has reduced the competitiveness of Eurozone producers, seen especially in the automobile manufacturing sector, something which may need to be addressed before Europe can recover. Similarly, in Japan, where 2012 lows were seen this month, competitiveness may struggle to improve until the Yen devalues.



AND THE IMPLICATIONS FOR INVESTORS?

How does this month's data relate to our investment decisions in equity markets? Unlike the previous month, when the mildly recovering data was coupled with an overheated equities market, this month the Dow sits closer to 13k, some 600 points from 2012 highs. While it is difficult to say where technical momentum will carry US indices, we may be more inclined to eventually buy oversold conditions in select industries, even after some disappointing PMIs this month.

Much of the current concerns in US equities relate to political and fiscal uncertainty, which are very real problems. However, it does provide stocks with a "wall of worry" to climb once we know the outcome of the election. Other weakness has related to earnings reports, and negative earnings guidance from key US companies. Much of this reflects the weakness in data we saw up until August, when ISM PMI for example was below 50.

If the leading indicators in the US recover into 2013, as we hope they will, stocks may surprise positively in the next round of earnings from a very low base of expectations - but of course, this relies on a more consistent improvement in business conditions. In short, we believe that based on current US leading indicators, we're more inclined to add risk on oversold conditions.

Despite this, as we've outlined in this article, there are greater apparent risks to the recovery trend than last month, especially emanating from Europe. As ever, it is worth being highly selective in entering positions, with a healthy appreciation of the risks - only adding to positions if it becomes clearer that there is positive momentum in the US economy.


That's quite a lot of analysis to consider from around the world. It is possible to derive different meanings from the trends in data over different timeframes, this is simply our take on the developing trends in PMI data.








Thursday 18 October 2012

US ECONOMY (October 18th 2012): Unemployment Claims Spike - but DON'T TRUST THE HEADLINES, the TRUTH is less exciting


Last week we wrote an article on the subject of Weekly Jobless Claims, suggesting that the 339k reading (a multi-year low) might be considered the first sign that QE3 was being felt in the labour statistics.

You can read that here.

However, it was soon made clear that part of this was a technical difficulty, with some of the claims not being recorded in that data release.

There has been a lot of buzz this morning about today's release of Weekly Jobless Claims, which unlike last week, stand near the highest recording of the year, at 388k.

We'd like to very quickly clear up that neither 339k nor 388k readings can be considered normal or accurate, and that it would be more reasonable to simply say that an average of 365k was recorded across the two weeks.

The reason being, both the 339k reading (revised up to 342k) and 388k readings are distorted by a hangover in claims making last week seem too good, and this week seem too bad.

It's very simple, in our analysis, we'll consider 365k to be the last two weeks' worth of readings. Funnily enough, that is almost exactly what analysts had forecast for both weeks.

There is no conspiracy in the first week of 339k claims, and no rampant shocking increase this week, it is simply a glitch in the data. Please don't be fooled by the political headlines, or prominent figures trying to paint the data in any other way - sadly it is nothing that interesting. Just take both weeks as 365k, which is what analysts expected for both weeks.



SO IF BOTH WEEKS ARE 365K, HOW DOES THAT CHANGE OUR VIEW?


Let's look at the chart as it will read in the record books, and the chart how we see it at BigMacroPicture (charts courtesy of the superb ForexFactory Calendar).




So we can still see the bullish downtrend in Claims until around February/March 2012 (350-360k). Then we see Claims spiking higher into the summer (365k-390k).

With last week's 339k reading, we had hoped a new trend of making new lower lows would commence, before we realised the technical error in the report.

With two readings of 365k instead, we must retract that statement for the time being. Not only have we failed to make a lower low in Claims since February (351k), Claims remain stubbornly high, with only very mild evidence of much recovery from the summer's 370k+ readings.

This is by no means a signal that things are worse than we expected, just that last week's analysis is invalidated until new genuine lows can be made in Unemployment Claims.

As such, we still wait for the first signs that QE3 is helping the US jobs market, which might only show up in the data after the US Presidential Election.



AND THE IMPLICATIONS FOR INVESTORS?

The market remains convinced that data points like these will improve over time, thanks to QE3, and that employment/consumer/business conditions will eventually start to improve in the data.

It began pricing that improvement in June, when equity market's bottomed - and has rallied to 2012 highs, even if that isn't too shocking from a valuation point of view.

Despite this, there are still a lot of factors suppressing equity markets at the moment, in terms of guidance (often a backwards-looking indicator), earnings (for a quarter we knew would be disappointing), skepticism over the global economy, and worries over the US fiscal cliff.

So there is still room for US equities to move higher if the data does start to improve - especially if the Presidential Election goes off without a hitch and the "fiscal cliff" issue is resolved.

However, it is highly likely that to some extent, the market is already partially assuming the data improves and the issues are resolved. The "no improvement in data" and "no fiscal deal" scenario would still serve as a serious risk to equity markets at these levels - so it is worth being patient and cautious with position sizing.


As ever, we'll continue to provide up to date analysis of these important economic indicators as they are released, and analyse the implications for investors and traders.









Tuesday 16 October 2012

US ECONOMY (October 16th 2012): Capacity Utilization Rate



The US Capacity Utilization Rate is an indicator to be respected.

Very few monthly economic indicators show long term trends in the US economy quite as simply as the CUR. It is exceptionally useful for providing noise-free, long term bullish and bearish cycles in the US economy, when viewed on longer timeframes.

If I had to give a complete novice ONE MONTHLY INDICATOR to describe how the economy is broadly doing, without noise or complications, I'd give them Capacity Utilization.

While it isn't a leading indicator, it is simple to use, and simple to understand the main trend. As you can see below, it is very effective for identifying different phases in economic conditions.


Charts Courtesy of Forex Factory

On the first chart, we can tell from 2000 to 2012 how broad cycles of expansion, contraction and consolidation take place. Unlike some of our other favoured indicators for month-to-month analysis, there are very few anomalous results - and there is little in the way of hyperbole or hysteria. Just big, broad, smooth trends in the US economy, which anyone could use to determine economic trends.

As we pointed out, unlike our other favoured indicators, this one is not a leading indicator - but rather, serves as long term confirmation of economic trends, without much fuss. We would never use CUR for instance, to try and pick out what the market is doing this month or last month - the easiest way to understand it is to check it out and play with it yourself:

US Capacity Utilization Rate (Forex Factory Chart)



SO WHAT IS CAPACITY UTILIZATION TELLING US NOW?


We can use US CUR as a confirmation indicator, to help us identify what part of the economic cycle we're in. We can use the trend to show us whether we want to be allocating capital towards businesses or not, via the equities market.

We know that over the course of several months, or even over a year, Capacity Utilization will consolidate at "mature" stages of a long term bullish or bearish cycle. It will also trend upwards, or downwards, in the middle of bullish or bearish cycles.

For instance, between 2006 and 2007, Capacity Utilization flattened out, before beginning to fall at the start of a new bear market. In 2002, like many economic indicators, it flattened out before recovering in 2003 - the start of a new bullish run for stocks. In 2009, it sharply turned around and confirmed we had entered a new expansionary bullish phase.

Only two months ago, in August, Capacity Utilization made new multi-year highs. However, in September and October, CUR fell quite sharply. At 78.0% and 78.3%, these are the two worst readings of 2012 so far.

What does this mean for our current cycle?

Well, pulling a chart up since 2009, the trend is clearly up. And while 78.0% and 78.3% are the worst two readings of 2012, they are still better than any number we saw in 2011. So we're clearly not in a confirmed bearish downtrend phase for the US economy at this time.

What it does mean however, that compared to January's 78.6% reading, the indicator has made zero progress in 2012 based on the last two readings, if the year ended now.

That compares with 2009: troughed at 68.1%, December reading at 71.5% (new trend high)
2010: January at 71.9% (the year low), December reading at 75.4% (the year high)
2011: January at 76.2% (the year low), December reading at 77.8% (2nd highest of year)

Considering Capacity Utilization was at 78.0% in November 2011, we can be suitably concerned that little progress has been made judging by September and October 2012's numbers.

We know it is not uncommon for this indicator to reflect weak medium term conditions, and 2012 has seen economic weakness from March throughout the summer. Given the advent of QE3, we would not be surprised to see CUR recover and make new highs in the coming months, and re-affirm the 2009 bullish trend. However, our point is, we'll have reasons to be worried if September/October's reading is not a blip.

If CUR does not continue making new highs, and plateaus at around this level, we would be concerned for the ongoing health of the 2009-present expansionary phase for US business conditions. At the very least we would have to acknowledge the maturity of the current cycle, perhaps similar to 2006.


AND WHAT ABOUT IMPLICATIONS FOR INVESTORS?


This is somewhat trickier to discuss.

Being a % indicator, Capacity Utilization oscillates between values of 0 and 100, depending on how much industrial capacity is being utilised in the United States. It does not account for the efficiency, productivity or technology being utilised in that space, or the profit (in dollars) that each company is making.

Perhaps most importantly, it says nothing about the valuation of businesses, only the trend in an ongoing cycle.

So as a stand-alone investment tool, there are obvious limitations, something that stretches to plenty of economic analysis.

However - in this market from 2000 onwards - identifying and understanding these patterns has been crucial to allocating capital.

In the absence of technological advances, deregulation or other "secular bull market triggers", earnings-multiple valuations have been generally suppressed in stocks, while the Dow has ranged between about 7k and 15k.

Timing has been extremely important - and that timing has depended on effective analysis of economic cycles. The US Capacity Utilization Rate has been one of the most sound indicators out there during that time for identifying those bull and bear markets.

So, whilst we remain in that environment, we feel it is important that equity investors pay close attention to whether or not - over the course of 2012/2013 - the US Capacity Utilization Rate returns to its bull market trend of higher highs.

At Big Macro Picture, we'll keep you up to date with our analysis of this indicator, what it's telling us about global macroeconomic trends, and what it could mean for global equity markets.




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