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.


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.


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.

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