Lighter Lockdowns, Lighter Economic Impact (at Least for Now)

IHS Markit’s flash November Purchasing Managers’ Indexes (PMIs, surveys of businesses aiming to tally the breadth of economic growth) for the UK and Europe hit the wires Monday, offering the first look at how new partial lockdowns are affecting economic activity. We think equity markets are looking beyond the present, so nothing in these reports has direct investing implications. Still, in our view, investors can benefit from assessing the new restrictions’ economic impact so far.

Exhibit 1 shows the services, manufacturing and composite (services plus manufacturing) readings for the UK, eurozone, France and Germany. PMIs measure the percentage of businesses reporting higher activity, so according to IHS Markit’s methodology, readings over 50 indicate expansion. If the composite reading seems out of step with services and manufacturing for any of these, that is likely because it measures output only, whereas the services and manufacturing gauges incorporate output, new orders and a couple of other components. Due to the way these reports are compiled, none of these numbers tell you how much each country grew or contracted this month, but we think they are a decent (and fast!) directional snapshot.

Exhibit 1: November Flash PMIs

Source: IHS Markit, as of 23/11/2020.

Across the board, manufacturing held up better than services. It even accelerated in the UK, likely due in part to businesses trying to front-run the Brexit transition period’s end on New Year’s Eve. But we think the main reason UK and eurozone factories reported expansion, overall and on average, is quite simple: They were open. Even as the UK, France and Germany tightened COVID restrictions considerably in November, they kept factories open. That is a change from the first round of lockdowns in March and April, when factories closed along with non-essential stores and services. That policy change, aimed at mitigating shutdowns’ economic impact, does seem to have helped overall activity hold up better this time, at least based on these PMI results. Services have tumbled, but the contraction thus far is milder than the one accompanying the first lockdown. Then, the eurozone composite PMI plunged to 29.7 in March and 13.7 in April—readings implying a gigantic hit.^[i]

One reason November’s composite readings aren’t as bad as that, in our view, is because economic activity hadn’t yet recovered fully from lockdown. Businesses are falling off a lower base. But also, our research indicates businesses and households have learned a few lessons about how to adapt. Headlines have been warning about an autumn/winter lockdown since before the springtime lockdown ended, giving society time to plan and adapt. Non-essential retailers have boosted their online presences. Pubs and restaurants have improved their takeout operations. Also helping matters, most European nations’ schools remain open, keeping parents in the workforce full-time. Lastly, whereas European governments were playing catch-up when it came to passing assistance measures last time, they were able to enact new restrictions and assistance simultaneously this time, helping ease a bit of the pressure on the people and businesses most affected. All of these silver linings have seemingly helped mitigate the impact so far.

With some countries expected to extend lockdowns, more negative readings in December or later this winter wouldn’t surprise. But equity markets still appear to us to be looking much further out, with each development on the vaccine front enabling them to better see a future where activity is back to normal. Take any forecast like this with a grain of salt, but investment bank UBS’s number crunchers project that if vaccines roll out quickly (inoculating 35% of the global population), it could speed the recovery and help global gross domestic product (GDP, a government-produced measure of economic output) grow 6.3% next year and 5.3% in 2020.^[ii] Now, any projection claiming precision down to the first decimal point is probably a little far-fetched, but the general point is sound enough: When normal life can resume, economic activity can probably snap back very quickly.

Overall, we think markets look about 3 – 30 months ahead. Early in a bull market (long period of generally rising equity markets), we think they look at the far end of that range. So in our view, global markets remain near new highs not because they are ignoring the risk of economic contraction in the very near term, but because they can see the recovery that will follow that contraction. They have had months to deal with the prospect of a second wave. To say that risk isn’t incorporated into prices already is to say markets have somehow ignored eight months’ worth of headlines. In our experience, that just isn’t how markets work.

So keep an eye on data, PMIs or otherwise. Take note of how people react to it. But we think it is most beneficial to do so with an eye toward measuring sentiment and how it squares with how things are likely to shake out over the next couple of years, not with an eye toward predicting equity markets in the near term.