Tracking Economic Activity with PMI

Intro

Explaining the Purchasing Managers Index (PMI)

• PMI is a monthly survey from the Institute of supply chain management (ISM) sent to the senior executives of over 400 companies across 19 industries, weighted by their contribution to GDP. 
•  It measures both upstream and downstream activities for manufacturing goods and services.
• The survey measures 5 major areas: 
  • new orders 
  • inventory levels
  • production
  • supplier deliveries
  • employment

Understanding PMI 

Purchasing Managers Index (PMI) determines whether business activities are expanding, contracting, or staying the same.

• Above 50, economic activity is improving.
• Below 50, economic activity is deteriorating.
• The further away from 50, the greater the level of change.

Why PMI matters

• The PMI provides insight to investors, market analysts, and company decision-makers.

• PMI provides one of the most thorough, easy-to-understand signals for economic growth expectations to which asset markets and policy react.​

The Macro Data

Over 70 years of fluctuating conditions

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Inflation

Elevated inflation (+3%) hurts economic activity

• The Feds 2-3% inflation mandate allows healthy inflation levels to boost economic cycles. However, when inflation rises above 3%, it eats away at economic growth, destroys demand, and creates uncertainty in financial markets.

Crude Oil 

Elevated oil prices hurt economic activity. 

• Oil is the largest commodity in the economy, with the most demand ranging from energy to plastics to everyday household products. 

• When crude oil prices rise to significantly high levels, it results in less spending, less earnings, and geopolitical instability.

Copper

Copper prices are tightly correlated to the health of economic activity

• Copper is the most widely used industrial metal in the economy as it is used for construction, electronics, and automobiles.

• If the economy tanks, the demand for copper tanks.

Fed Funds Rate

• Rate hikes are used to tighten financial conditions to prevent high levels of inflation.

• As financial conditions tighten, economic growth slows.
• If conditions tighten too much or too fast, it can destroy growth, throwing the economy into recession and the stock market into correction territory. 

Rate cuts to the rescue

• Rate cuts help restore economic activity by lowering the cost to borrow and the cost of existing debt giving.

• Rate cuts mean more spending and investment for corporations, governments, banks, and the average consumer.

Fed Balance Sheet

Expanding the balance sheet 

• The Fed aims to stabilize economic growth by injecting liquidity (expanding the balance sheet) to stimulate markets, preventing further collapse.

• Injecting liquidity means they purchase U.S treasuries and mortgage-backed securities to lower the interest rate, ultimately easing financial conditions.

The Dollar Index

On average, dollar strength is correlated to decelerating economic activity (PMI).

• When growth decelerates during market uncertainty, fear, and doubt, capital flows out of assets into dollars. 

• ​As the business cycle turns down, financial conditions tighten, growth decelerates, and the dollar becomes a flight to safety.​

• During or foreseeing economic shock will incentive investors to build dollar positions.

Bond Yields

Manufacturing growth and bond yields peak together

• As bond investors for-see slowing growth or economic uncertainty, they migrate to bonds for fixed-income payments, ultimately pushing bond yields lower.

• Yields decline as growth declines meaning the demand for bonds increases as growth slows.
• Recessionary environments attract fixed income assets which accelerate demand for bonds.
• Bond yields can decouple from growth correlations when inflation expectations are heading to dangerous levels.

Equities

When the PMI decelerates during all-time high stock valuations, stocks correct. 

• Declining growth is one of the strongest recessionary signals causing investors to migrate a portion of their capital from equities to dollars and bonds.

• Although some stocks can perform during the PMI decline, most stocks get crushed when the decline accelerates below 49-48.

• ​PMI is a crucial measure of business activity impacting growth expectations.

• Significant changes in PMI impact economic growth expectations, asset prices, and policy decisions.