Are July’s Business Surveys Normal?

Has a summertime swoon arrived? July business activity contracted in major developed economies, including the US and eurozone, per the latest surveys from research firm S&P Global. We aren’t dismissive about today’s global headwinds, but we think it is critical to ask whether any of this information is surprising to markets—and in our view, the answer is no. July’s purchasing managers’ indexes (PMIs) don’t reveal much new on the economic data front, in our opinion, and we think stocks likely reflect this weakness to a large extent already.

As Exhibit 1 shows, S&P Global’s July flash (i.e., preliminary) PMIs weakened across the board from June and missed expectations.^[i]

Exhibit 1: The Latest PMIs

Source: FactSet, as of 22/7/2022.

PMIs are surveys that seek to measure growth’s breadth. Readings above 50 suggest a majority of surveyed companies recorded rising business activity in the reporting month whilst below 50 indicate more business saw falling activity. So the former implies broad expansion whilst the latter points to contraction. Since July PMIs were below 50 in the US and eurozone, we weren’t surprised many financial publications’ coverage focussed on them. The US July composite PMI, which aggregates services and manufacturing output, dropped below 50 for the first time since June 2020.^[ii] Moreover, the sub-50 services PMI spurred slowdown chatter amongst financial commentators we follow since the sector comprises the lion’s share of US output.^[iii] On the Continent, the eurozone composite PMI fell below 50 for the first time since February 2021.^[iv] Eurozone manufacturing and services new orders—which we think are a forward-looking economic indicator since today’s orders become tomorrow’s production—also fell in July, with manufacturing new orders down a third straight month.^[v] The alleged takeaway from July PMIs based on the coverage we read: Global growth is losing momentum as pent-up services demand fades amidst rising prices, and the eurozone appears to have an even higher likelihood of entering recession (a broad and extended economic downturn).

Now, we think it is important for investors to analyse the data objectively, and July’s flash PMIs highlighted some well-known, widely discussed weak spots. For example, elevated inflation (economy-wide rise in prices) has dominated financial outlets we monitor globally, with consumer price measures in the US, UK and eurozone at multi-decade—even record—highs.^[vi] Higher prices weigh on households and businesses, forcing them to make do with less or cut expenses. As the German July flash PMI noted, “… inflation … was a notable feature behind the worst performance of private sector activity since the height of the first pandemic wave in the spring of 2020.”^[vii]

But looking more broadly, July PMIs parallel recent economic data, which have been mixed. In early June, we observed an emerging trend in European economic data—a divergence between so-called soft data (e.g., PMIs and other survey-based indicators) and hard data (e.g., output measures like industrial production and retail sales). Whilst PMIs were broadly expansionary early in 2022, industrial production and retail sales had many setbacks.^[viii] Now PMIs are mixed, and it is possible hard data could worsen.

However, we think investors may benefit from keeping some context in mind. One, hard data come out at a lag. The latest eurozone industrial production and retail sales data cover May, and July figures won’t arrive until September. Even if they confirm weak July PMIs, it will be old news by then, likely long priced in by stocks, which we think are forward-looking. Two, we have found monthly data can be volatile, so extrapolating July’s figures forward is a mistake, in our view—what just happened won’t necessarily repeat.

Moreover, July’s PMI weakness may actually be a return to normal. We have observed economic data globally following a general trend during the pandemic: Lockdowns roil output, but once they ease, the data jump as economic activity returns. However, the subsequent boom doesn’t last for long, and activity eventually slows—as illustrated by the UK services PMI over the past two and a half years.^[ix] (Exhibit 2)

Exhibit 2: UK Services PMI, January 2020 – June 2022

Source: FactSet, as of 26/7/2022. S&P Global services PMI for the UK, January 2020 – June 2022. Readings above 50 imply expansion.

Taking a longer view, the latest PMIs may not be warning signs of economic trouble, but rather, a return to growth trends that dominated before COVID, in our view. That era’s slow growth was just fine for stocks.^[x]

Now, we acknowledge myriad headwinds accompany and complicate a return to normal. It is possible ongoing developments (e.g., Europe’s energy crunch and the UK’s cost of living crisis) weigh on growth and may even drive some individual country or regional GDP contractions. But stocks are already behaving as we would think likely if a shallow recession were in the offing—some European countries, including Germany and the Netherlands, have entered bear markets (broad stock market declines of -20% or worse) this year, suggesting stocks are incorporating economic weakness into prices.^[xi] If the data confirm a mild economic downturn, the negative surprise power would likely be next to nil, in our view—stocks have likely been digesting the myriad forecasts of a recession tied to inflation, high energy prices and other widely discussed headwinds for a while. Unless a much larger downturn lurks—which doesn’t look likely to us right now—we don’t think the global economy’s fundamentals are in as dire straits as broadly discussed amongst widely followed economists and supranational organisations. A less bad outcome can boost stocks if economic forecasts are as dim as they are right now, in our view.