Position: Long Germany (EWG); Short Spain (EWP), Short Euro (FXE)
As a leading indicator, the Purchase Managers Index (PMI) is one critical data point we use in our fundamental analysis. While our bullish call on Germany remains (see our portal for recent analysis), we’re acutely aware that ‘gravity’ could prevent this number from improving over the coming months.
Below we’ve pulled back a chart of German PMI over the last eight years and overlaid the DAX. There are two major call-outs:
(1.) We’re now above the 60 level, a critical threshold for the Manufacturing PMI (the most current reading in April is 61.5 versus 60.2 in March).
(2.) The change in the second derivative from March PMI to April slowed compared to previous months, an early sign that may suggest the expedited move since early 2009 could turn.
(3.) If history is any gauge, and if April was the peak in PMI, we’re likely to see the DAX pull back.
As some of our subscribers have pointed out, the bailout of Greece and potentially other Euro member states could create downward contagion in Germany (the top loan sponsor), therefore threatening a long Germany position. While we wouldn’t disagree that contagion is a risk, over the intermediate term we see a weaker Euro as a bullish catalyst for the country’s export base and continue to believe that Germany’s fiscal health will help drive its equity market over its debt-laden peers. To play this divergence, which is one of our Q2 2010 themes (Sovereign Debt Dichotomy), we’re long Germany, short Spain. Currently there is a 16.2% spread between the DAX and the Spain’s IBEX 35 year-to-date.
While we expect to see further slowing (and mild contraction) in PMI in the coming months from gravity as risks surrounding contagion from the sovereign debt bubble play out, we believe the data still supports our bullish call on Germany.