Q: PMI’s in both Europe and China don’t seem to be trending as bad as in the U.S. In fact Europe seems to be growing and China stabilized. As such, why is the call for them to get worse from here if some leading indicators are better and they’ve been cutting [rates] already?
Due to a variety of fiscal and monetary policy support measures, economic growth in China has indeed stabilized – for now at least. We discuss these dynamics in great detail on slides 38-57 of our 9/15 presentation titled, “Our Latest Thoughts On C-H-I-N-A”.
We do not, however, think it would be wise for investors to bet on a material acceleration from here – especially considering that Chinese growth continues to slow on a trending basis across a variety of key metrics, specifically: industrial production, exports, composite PMI, consumer confidence, business confidence and PPI.
We think the structural headwinds to Chinese fixed asset investment growth and household consumption are incredibly dour and wildly misunderstood by consensus. Refer to slides 7-19 of the aforementioned presentation for more details.
Looking to Europe, we continue to cite steepening base effects as the primary driver of our dour outlook for European economic growth. All else being equal, difficult GDP compares in 1H16 represent a meaningful headwind to the trend in various European high-frequency growth data. The Eurozone and U.K. are not unlike the U.S. in this regard.
In terms of cratering a narrative around the aforementioned mathematical reality of steepening base effects in the Eurozone, industrial production, exports, consumer confidence, business confidence and PPI are all slowing on both a sequential and trending basis throughout the region. Its composite PMI is still slowing on a trending basis and household consumption growth is trending at an unsustainably elevated rate in the context of our outlook for ECB monetary policy and it’s likely [negative] impact on the EUR.
In terms of cratering a narrative around the aforementioned mathematical reality of steepening base effects in the U.K., global headwinds have caused U.K. export growth to slow on both a sequential and trending basis, which is negatively impacting business confidence (also slowing on both a sequential and trending basis) and perpetuating a negative inflection in industrial production growth per the most recent data. Additionally, consumer confidence is slowing on both a sequential and trending basis, which may cause the unsustainably elevated trend in household consumption growth to subsequently inflect. The trend of deceleration in the U.K. composite PMI would seem to imply as much.
Q: Why do you not seem to heavily weight PMI’s [in your growth forecasts]? These seem to have a pretty good record as predictive indicators [of growth], at least for industrial stocks.
We tend to weight any given high-frequency indicator on a country-by-country basis relative to that sector’s contribution to the economy. For example, our expectations for U.S. economic growth will never deviate too far from the trend and/or our outlook for household consumption or the services sector, which account for 68.7% and 77.7% of U.S. GDP, respectively. That compares 13.4% and 20.7%, respectively, for exports and the manufacturing sector.
We run a predictive tracking algorithm that pulls a number of core indicators into our growth and inflation forecasts and analyzing them from a rate-of-change perspective allows to make forward-looking inferences that many investors tend to rely on mere conjecture for.
With respect to PMIs specifically, we do place a decent amount of weight on them as a directional indicator of domestic economic growth. For reasons alluded to above, the ISM GDP-Weighted Composite PMI series has a tighter correlation to YoY U.S. real GDP growth than the ISM Manufacturing PMI series. Both indicators carry the same weight in terms of being a directional indicator for QoQ SAAR real GDP growth.
That PMI readings continue to slow on a trending basis across both the domestic manufacturing and services sectors should lend a significant degree of pause to any bullish narrative surrounding domestic economic growth. We continue be among the most accurate firms (if not the most accurate) on the Street with respect to forecasting both trends and inflections in U.S. and global GDP growth and our forecasts for both remain well below consensus with respect to the intermediate-term.
All told, we continue to view the “global growth has bottomed” claim as reckless at best and we detail precisely why that is the case in our 11/5 note titled, “Global Growth Has Not Bottomed”.
Best of luck out there,