February’s Growthy Data—and the Iran War’s Souring Sentiment

There is nothing like a sudden turn in world events to make economic analysts confess a basic truth: All data are backward-looking. We saw it last spring, when all early-year data got dismissed with a yah, but that was before tariffs. Now it is happening again. Whether it is UK Chancellor of the Exchequer’s “Spring Statement” of economic forecasts or the latest spate of purchasing managers’ indexes (PMIs), headlines greet new data with yah, but that was before Middle East conflict erupted. The implication: The war upends global economic fundamentals and risks truncating this expansion. We see positive surprise potential building here for stocks.

Let us look at this through the PMI lens. PMIs, friends to investors everywhere, are the timeliest monthly economic snapshot. They don’t measure output and aren’t perfect. But they are handy surveys tabulating how broad-based growth is. Readings over 50 indicate expansion, with a higher reading meaning more widespread growth—which most interpret as an acceleration. S&P Global produces services, manufacturing and occasionally construction PMIs for most developed and major emerging markets, along with a handy global PMI that mashes all these together.

In February, the global composite PMI (manufacturing and services output combined) rose from 52.6 in January to 53.3, a 21-month high.^[i] Services and manufacturing each ticked up, with export orders also expanding for the first time in a year. Among manufacturing highlights, the long-beleaguered eurozone flipped to expansion at 50.8, a 44-month high, with forward-looking new orders finally up.^[ii] Germany, a long-running sore spot, jumped from 49.1 to 50.9, with new orders rising there, too.^[iii] US manufacturing slowed a bit but stayed expansionary, while China’s manufacturing PMI surged from 50.3 to 52.1.^[iv] UK manufacturing ticked a bit slower, but new export orders notched their fastest growth in four and a half years. Manufacturing may be a small chunk of output in all these nations, but given how weak it has been since COVID, improvement is a shot in the arm.

Services—the bulk of economic activity—also looked good. China’s services PMI jumped from 52.3 to 56.7, an almost three-year high.^[v] US services slowed, echoing manufacturing, but the UK’s stayed strong at 53.9 with continued new order growth.^[vi] The eurozone also improved, again boosted by Germany (up from 52.4 to 53.5), and Japan was solid again.^[vii] So were the non-oil private sectors in the UAE (55.0), Kuwait (54.5) and Saudi Arabia (56.1).^[viii] Around the world, business activity is growing across the vast, diverse range of services that drive growth.

Ordinarily, the more eyeballs land on improving economic fundamentals, the more markets price them. As expectations lift to match this improvement, you need ever-faster growth to continue delivering the positive surprise that pushes stocks up the wall of worry. Yet the widening Middle East conflict is knocking expectations. Not just because it keeps euphoria at bay, but because it increases positive surprise potential.

This naturally means all the fears about conflict roiling the global economy would have to prove overly pessimistic. If it turned out they weren’t pessimistic enough, stocks would have to price that, and it would be bad. But in this case, it looks like the fear is overshooting. With drone attacks now spreading to Azerbaijan, the conflict’s global footprint is 3.5% of GDP.^[ix] The actual activity lost in these places is a fraction of the whole.

What about oil and natural gas? Prices today remain well short of spikes in 2022, when sanctions and general blowback from Russia’s invasion disrupted global supply and sparked fear of severe shortages. Those fears didn’t come true. Neither did a global recession, even though Germany and a handful of others struggled. Oil spending much of the year over $100 didn’t crush output or consumer demand. This isn’t the 1970s, when the global economy was more energy-intensive and the Middle East was a major production swing factor. Growth is much more energy-efficient now, while global energy production is broader.

This also cuts against fears of the Strait of Hormuz’s “closure” choking global growth. As we wrote earlier this week, “closure” is a misnomer. The Iranian Navy doesn’t operate official gates or checkpoints in this narrow waterway and likely can’t officially close it to traffic. While ships have dropped anchor outside the Strait, this is more to do with insurers canceling policies and jacking up rates to compensate for war risk. The US Development Finance Corporation is now stepping in as insurer of last resort, a program some fear will be so effective that it generates an existential threat for London’s insurance marketplace—an implicit admission that tanker traffic likely resumes soon. US Naval escorts add another layer of protection for passing ships, as they did for ships traversing the Red Sea when Yemen’s Houthi rebel militia attacked them in 2023. Furthermore, Saudi Arabia is already pushing more output through pipelines that avoid the Strait, and Venezuela’s backlog of oil and gas is in motion toward western nations, now that sanctions are gone.

The insurance issue is just one place headlines are trying to have it both ways. Here is another alternate scenario to think through: What if oil and gas stay high? That means higher oil rents for all the petrostates currently under attack, which feeds into their economies and their sovereign wealth funds’ international investment. An economic positive. It also means higher revenues for price-sensitive oil and gas firms producing across the US, North Sea, Canada, Australia, Brazil, Argentina, on and on and on. These, too, feed into local investment and growth.

A suggestion: Tragic as war is, resist the temptation to think of any geopolitical development as automatically “good” or “bad” from an economic standpoint. That isn’t how markets or the world work. Instead, think through the framework of winners and losers. All change creates winners and losers. But when the winners outweigh and outnumber the losers, and when the losers aren’t surprising, that sets the stage for stocks to defy sentiment and conventional wisdom. That stage looks nicely set today.