Your First 2023 Economic Check-In

January isn’t over yet, but thanks to the fine folks at S&P Global, we have our first inkling of how the global economy started 2023. Yes, flash purchasing managers’ indexes (PMIs) for January are out, and there are some hints of good news—further suggesting 2023’s economic landscape has a good chance of shaping up better than dismal forecasts project. Big negative economic surprise that hits stocks hard remains unlikely, in our view.

The Eurozone Expands a Bit

Most noteworthy? The eurozone’s composite PMI, which combines manufacturing and services output, rose to 50.2.^[i] PMI readings over 50 imply expansion, so this suggests output rose a smidge for the first time since June.^[ii] Manufacturing stayed in contraction at 48.8, but services flipped to growth at 50.7.^[iii] Now, the two individual countries reporting thus far told opposite stories. Germany and France both stayed in contraction at 49.0 and 49.7, respectively—but German services grew while French services contracted, while Germany’s manufacturing PMI contracted and France’s grew.^[iv]

So, under the hood, things are mixed. Still. But in the eurozone, that isn’t bad for stocks. Last autumn, the vast majority of forecasts penciled in a deep eurozone recession—with Germany bearing the brunt—as the region drained its natural gas reserves in winter and had to resort to rationing and blackouts. These projections haven’t come true. Instead, the region filled reserves ahead of schedule, got a head start on replacing Russian supply and used an unseasonal warm stretch to replenish reserves after winter’s initial cold snap. With the energy situation going much better than expected, the region’s economy seems to be muddling through.

The key word is “muddling.” The eurozone economy isn’t in great or even necessarily good shape. Output may have improved, but new orders are still falling—not great, considering today’s orders are tomorrow’s production. Yet on the bright side, cost pressures are easing, and demand is resilient enough that businesses have been able to push more of last year’s increased costs to customers. In our view, this is encouraging, as it means the inflation bulge is working its way through the system and should be digested soon enough.

So Does Japan

Japan’s PMIs look similar to the eurozone’s: composite back in growth at 50.8, services accelerating to 52.4 and the manufacturing PMI contracting at the same rate as December (48.9).^[v] But the drivers are different. Manufacturing’s big headwinds were weaker demand in China—due first to China’s Zero-COVID policies and then to the COVID outbreak as restrictions eased in December—and the weak yen, which jacked up energy costs. Higher costs hit services, too, but manufacturing is more energy intensive, so it suffered an outsized hit. Services also benefited from a big plus: the continued easing of domestic COVID restrictions. Not only is the government letting people move around more, but they are also encouraging folks to do so via the Nationwide Travel Discount Program.

It is too soon to know whether this is enough of a plus to put Japanese GDP back in the growth column. PMIs show the breadth of activity, not how much activity grew or fell. But in a perhaps counterintuitive way, the split between manufacturing and services shows reason for optimism. Reopening tailwinds probably won’t last. They didn’t in the US, UK and Europe. Yet maybe they buy enough time for lower energy costs (courtesy of the stronger yen and falling global commodity prices) to kick in. That is a positive scenario we haven’t seen discussed much, and even if it doesn’t mean rip-roaring growth, it would keep Japan contributing to global growth.

The UK and US Stay in the Doldrums

Alas, growth wasn’t universal. Composite PMIs in the US and UK stayed in contraction, with manufacturing and services below 50 in both. Contraction in the US was at least less widespread, with the composite PMI inching from December’s 45.0 to 46.6, but the UK’s deepened to a 24-month low 47.8 as services deteriorated.^[vi]

In both countries, businesses reported the same long-running headwinds: inflation and customers’ overall hesitancy to ramp up. That isn’t great, but it suggests that at this point, people are increasingly chewing over the same rehashed fears. New concerns aren’t entering the spotlight and shaking things up. The more the old concerns hit PMIs and other data, the more people can see their fears manifesting. In a weird way, that could help people digest them and move on—if nothing else, seeing the headwinds have their feared impact can end the uncertainty. Sometimes that is all stocks need. Contracting PMIs also help take the surprise power out of a recession, should we indeed get one. That, too, speaks to stocks moving on much faster than folks seem to anticipate now.