What to Consider in August’s Purchasing Managers’ Indexes

Has a global recession—a period of contracting economic output—begun? Financial commentators we follow asked that question Tuesday after S&P Global’s flash US Purchasing Managers’ Indexes (PMIs) for August showed declining output in most major economies.^[i] In our view, that makes today ripe for a timely reminder: Regardless of what the global economy is doing this month, we think stocks generally look about 3 – 30 months out and have likely already digested whatever business surveys and output metrics will eventually confirm happened.

PMIs, unlike so-called hard data like retail sales and industrial production, aim to use survey responses to determine the economy’s general direction. They ask participants how business evolved across a range of categories including output, new business, employment, inventories, supplier deliveries, prices and others, then mash the responses into a number. Readings over 50 generally indicate expansion, with growth broader the farther above 50 it is. Similarly, under 50 normally means contraction, with lower readings implying widespread declines.

Exhibit 1 shows the flash results for August, which S&P says include about 85% of expected responses.^[ii] The Manufacturing and Services columns show headline indexes—the aforementioned mashups. The Composite column aggregates Manufacturing and Services output only, hence its apparent divergence.

Exhibit 1: August’s Flash PMIs

Source: FactSet and S&P Global, as of 23/8/2022.

Now, in our view, PMIs aren’t a perfect reflection of actual economic growth. The survey asks if activity was higher, lower or the same—broad descriptions that show direction only. We think there is a world of difference between a bit higher and way higher, and the combination of all those differences eventually determines the actual growth rate. Said differently: We know from these surveys that a majority of businesses in all of these places except the UK reported falling output. But we don’t know if those were big drops. Nor do we know if the minority that reported higher output might have enjoyed fast enough growth to offset those in decline. We probably won’t have a better picture until the corresponding output data come out several weeks from now.

Still, our research finds PMI trends have a solid history of corresponding with the economy’s general direction, so we think it is fair to surmise that the global economy is at least enduring a slowdown right now, if not an actual contraction. We say this not to alarm, but because it is important to look negatives in the eye as well as positives, in our view. But more importantly, at this point, is anyone surprised that economic conditions appear to be wobbling? According to S&P Global’s press releases, businesses across the world cited supply chain pressures, full inventories, input prices and a general sense of prudence and unease amongst clients as headwinds.^[iii] But hese aren’t new considerations: They are the exact things commentators we follow have warned would cause trouble for months, which we think contributed heavily to this year’s stock market downturn.^[iv] In our view, the sheer lack of surprise power here is a powerful sign for stocks.

When sentiment hits stocks, as we think it did this year, we think it unfolds in a repeatable cycle. First, a perceived negative gains traction in headlines, hurting stocks. Then it snowballs as headlines sketch out worst-case scenarios and extrapolate every potential negative forward, and the decline escalates. From here, sometimes the warnings prove false, and people seemingly move on as if the whole thing never happened. Sometimes, the warning comes true—usually in a milder way than anticipated—and seeing it come true also enables investors to get over it and get on with it. Getting confirmation zaps the uncertainty—people don’t have to wonder anymore. It wouldn’t surprise us if that played out regarding investor sentiment toward the global economy, given the plethora of perceived negatives that have hogged headlines for months. We think PMIs and other metrics could easily trigger a general sentiment of guess the bad times came after all, and it isn’t so bad. What next? Couple that with easing price pressures, which survey respondents reported across the board, and we think it all points to a high likelihood of investors feeling some relief.^[v]

So no, August’s PMIs aren’t good news, in our view. But we also don’t think they are reason to avoid stocks now. They may seem out of sync with global stocks’ bounce since mid-June, but our studies of market history find stocks regularly rebound before the economy does.^[vi] Remembering these first principles is key to navigating these rocky stretches, in our view.