“The September PMI data will add to worries that the UK economy is heading towards a bout of ‘stagflation.’”[i] Across the English Channel, commentators we follow bemoaned that “the Delta variant of coronavirus hit demand and supply-chain constraints pushed input costs to a more than two-decade high.”[ii] Japan’s results allegedly “underscor[ed] the protracted impact of the coronavirus pandemic,” whilst America’s supposedly showed “persistent supply-chain problems hit activity.”[iii] Reading those takes on September’s flash purchasing managers’ indexes (PMIs, preliminary business surveys tallying the breadth of economic growth that are based on 85% – 90% of the final survey’s responses), you might think these data point to contraction in many parts of the developed world. But if so, that isn’t what the data show, as we will explain. Why the dour reaction, and what should investors make of it? Here we help put commentators’ latest PMI pronouncements into perspective.
September’s flash PMIs did broadly tick down from August. (Exhibit 1) But all remain well above 50, signalling expansion—except Japan’s, which hasn’t posted an expansionary reading since April (and, before that, January 2020).[iv] So for the US, UK, eurozone, Germany and France, September’s downticks don’t imply contraction—they just suggest growth wasn’t quite as broad-based as last month’s.
Exhibit 1: Major Economy PMIs
Source: FactSet and IHS Markit, as of 24/9/2021.
Services activity—the lion’s share of developed world GDP—saw the biggest drops in the eurozone, leading composite levels’ declines.[v] But this simply follows the US’s path a month prior: America reopened first from lockdowns amongst western nations, enjoyed the post-lockdown surge in economic activity first, and also saw that initial burst fade first.[vi] That pop, which stemmed from unleashing pent-up demand in late spring and early summer, always appeared unlikely to last, in our view. Once people got the initial rush back to shops and restaurants out of their system, it seemed to us they would logically return to a slower pace of life. We think this is the chief force behind the recent PMI downticks—hence, declines from very high levels earlier shouldn’t shock.
Manufacturing seemingly held up a bit better, due partly to lengthening supplier delivery times.[vii] Longer supplier delivery times contribute positively to the headline index since, normally, they signal robust demand as producers can’t keep up with incoming orders. That is the case now, but respondents also reported there are severe shortages hampering production.[viii] Even stripping that skew out, though, results were still good, in our view—manufacturing output subindex levels were in the low 50s (save Japan’s at 48.1).[ix] In other words, despite supply constraints clearly weighing on factories, most PMI surveys suggest output is still expanding, which implies problems remain surmountable.
Demand remained strong outside Japan, too, according to those PMIs’ new orders subcomponents, although that may be less of a positive signal than it would otherwise.[x] Ordinarily we look to new orders as the forward-looking component of PMIs, but for the moment, we don’t think they have much predictive power, if any. In theory, today’s new orders are tomorrow’s production, but supply shortages scramble any foresight they have now, in our view.
For investors, we think many commentators’ negative responses to expansionary PMI readings is a sign of sentiment, not fundamentals. PMIs are some of the most widely watched reports out there based on financial publications we follow. Nowadays, so are supply-chain issues, like the much publicised port backups and semiconductor shortages we see covered almost every day as COVID outbreaks and lockdowns plague key global hubs. The same goes for China’s recent electricity shortage and rationing. We think global markets discount such widely available information—and well-known problems—in real time. In our view, equities’ direction depends on how reality develops against those expectations, not the generally backward-looking news flow itself.
According to our research, prevailing pessimism sets a low expectations bar for reality to clear, so when the economy’s actual path isn’t as bad as feared, equities typically benefit. Weaker economic growth needn’t be an impediment. Based on our analysis, over the 3 to 30 month timeframe we think markets generally weigh, bottlenecks will likely prove passing—ergo economic weakness and price pressures stemming from them likely also prove temporary. We don’t think they materially shift the global economy’s longer-term outlook. Besides, slower growth always seemed likely to us post-reopening, a baseline we think equities have long since incorporated. Supply disruptions this year may have added another wrinkle, but in our view, they probably aren’t the cause of an economic downturn markets didn’t anticipate.
[i] “Output Growth Slows Further, While Selling Price Inflation Hits Record High,” Staff, IHS Markit, as of 23/9/2021.
[ii] “Euro Zone Business Activity Slowed in Sept, Input Costs Hit Over Two-Decade High,” Staff, Reuters, 23/9/2021.
[iii] “Japan’s Sept Manufacturing Activity Growth Slows - Flash PMI,” Staff, Reuters, 23/9/2021. “US Economic Activity Slows in September Amid Delta, Supply Shortages - IHS Markit,” Xavier Fontdegloria, Morningstar, 23/9/2021.
[iv] Source: FactSet, as of 27/9/2021. Jibun Bank PMI Composite Sector Output, January 2020 – September 2021.
[v] Source: The World Bank, as of 27/9/2021. Statement based on US, UK, Japanese, eurozone, French and German services industry share of GDP, 2019.
[vi] Source: Federal Reserve Bank of St. Louis, as of 27/9/2021. US GDP, Q2 2020 – Q2 2021.
[vii] Source: IHS Markit, as of 24/9/2021. US, UK, Japan, eurozone, Germany and France flash PMI reports, September 2021.
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