Coronavirus on Purchasing Managers’ Minds

As market volatility persists, headlines declare that stocks are finally wising up to the coronavirus’s potential global damage. Flash (a.k.a., preliminary) purchasing managers’ indexes (PMIs) out of the developed world seem to bolster this notion, with firms around the developed world noting the outbreak has crimped business. Yet February’s numbers also show that, as recently as February 19/20, economic activity hadn’t plunged—important context for investors to keep in mind as they size up big stock swings since. 

Exhibit 1 shows how IHS Markit’s February’s flash PMIs—which reflect 85% – 90% of total respondents—compare to January’s final numbers.

Exhibit 1: February ‘Flash’ Vs. January PMIs

Source: FactSet, as of 2/25/2020. IHS Markit PMIs for the US, eurozone, UK and Japan. US and eurozone surveys were taken February 12 – 20. UK and Japan were completed February 12 – 19.

As a refresher, PMIs are monthly business surveys. Respondents share whether they saw more or less economic activity during the reporting period. Readings above 50 suggest a majority of firms grew; below 50, more companies contracted. PMIs don’t measure the magnitude of that growth or contraction, but they are a quick snapshot of businesses conditions. In this case, Markit collected the US and eurozone surveys between February 12 and 20; the UK and Japan between February 12 and 19. While those time periods immediately precede the recent market swings, that makes them about the most timely gauges of business activity available—helping give a sense of economic conditions after about a month of coronavirus fears. We covered the UK last week—check that out here—so we will focus on the US, euro land and Japan.

We start with the US, where eyeballs bulged at the composite PMI’s lowest reading since 2013. The services PMI—which covers the vast majority of GDP—also contracted. Many respondents pinned the weakness on the coronavirus and political uncertainty. IHS Markit’s Chief Business Economist Chris Williamson noted, “Total new orders fell for the first time in over a decade. The deterioration was in part linked to the coronavirus outbreak, manifesting itself in weakened demand across sectors such as travel and tourism, as well as via falling exports and supply chain disruptions. However, companies also reported increased caution in respect to spending due to worries about a wider economic slowdown and uncertainty ahead of the presidential election later this year.”

Business disruptions and increased political uncertainty aren’t positives, but we think they are short-term headwinds—unlikely to derail the US expansion. Like natural disasters (e.g., hurricanes) or policy changes (e.g., tariffs), disease outbreaks tend to cause businesses to pause or move around—not cease altogether—spending decisions. Similarly, US political uncertainty will fall as we get closer to November, giving markets a better idea of the probable election outcome. At this juncture, it is too early to handicap the presidential or congressional races.

Moreover, history shows an unexpected dip doesn’t necessarily portend trouble. IHS Markit’s US composite PMI last contracted in October 2013, around the government shutdown. It was a blip, and the economic expansion and bull market continued. Similarly, across the pond, the UK’s composite and services PMIs fell below 50 in July 2016. Many projected an extended period of weakness. It, too, turned out to be a blip, reflecting a one-time, Brexit-related sentiment knock.  

Meanwhile, the eurozone composite PMI surprised many with its highest reading in six months. Manufacturing contracted again—extending its recent trend—as companies blamed coronavirus-driven delivery delays. While manufacturing’s forward-looking new orders subindex also contracted, fewer companies reported lower activity—suggesting the tide for the besieged industrial sector may be turning. Moreover, a majority of services firms continued expanding—an underappreciated positive given the services sector generates the majority of eurozone GDP growth.

As for Japan, February’s flash PMIs contracted across the board. The coronavirus outbreak weighed here too, hurting services industries like tourism particularly hard. It is yet another setback for Japan’s economy, where domestic demand is still recovering from last year’s destructive typhoon and October sales tax hike. The coronavirus may add a headwind, but it isn’t necessarily a game-changer: Japan has long struggled with tepid domestic demand. Growth relies on external demand, and in the near term, those prospects appear weak: February’s new export orders declined in manufacturing and services. While the ongoing global expansion should benefit Japanese multinationals, persistent domestic headwinds create tough sledding for companies tied to the local business environment, in our view.

February’s snapshot of developed world economies shows a mixed picture, but this isn’t uncommon during global expansions. Not every sector or country will expand uninterrupted. Pauses and pullbacks happen. Most importantly, the latest PMIs don’t indicate a rapid deterioration in the underlying economic fundamentals supporting the global bull market. It looks more like a brief coronavirus panic among select businesses, which seems unlikely to have a lasting impact. Until something changes—i.e., the fundamentals meaningfully weaken to the point of a global recession, or investor sentiment exceeds economic reality—the ongoing global expansion supports a bullish outlook.