Lighter Lockdowns, Lighter Economic Impact (at Least for Now)

IHS Markit’s flash November Purchasing Managers’ Indexes (PMIs) for the US and Europe hit the wires today, offering the first look at how new partial lockdowns are affecting economic activity across the pond. They also provide a preview for what we might expect American data to show next month as restrictions tighten, given Europe is running about a month ahead of most US metro areas in terms of Lockdown 2.0. We think stocks are looking much further out, so nothing in here is predictive, but having reasonable expectations can help keep you cool if sentiment takes a hit.

Exhibit 1 shows the services, manufacturing and composite readings for the UK, eurozone, France and Germany. PMIs measure the percentage of businesses reporting higher activity, so readings over 50 indicate expansion. If the composite reading seems out of whack with services and manufacturing for any of these, that is because it measures output only, whereas the services and manufacturing gauges incorporate output, new orders and a couple of other components. None of these numbers tell you how much each country grew or contracted this month, but they are a decent (and fast!) directional snapshot.

Exhibit 1: November Flash PMIs

Source: IHS Markit, as of 11/23/2020.

Across the board, manufacturing held up better than services. It even accelerated in the UK, likely due in part to businesses trying to front-run the Brexit transition period’s end on New Year’s Eve. But the main reason factories reported expansion, overall and on average, is quite simple: They were open. Even as the UK, France and Germany tightened COVID restrictions considerably in November, they kept factories open. That is a change from the first round of lockdowns in March and April, when factories closed along with non-essential stores and services. That policy change, aimed at mitigating shutdowns’ economic impact, does seem to have helped overall activity hold up better this time. Services have tumbled, but the contraction thus far is milder than the one accompanying the first lockdown. Then, the eurozone composite PMI plunged to 29.7 in March and 13.7 in April—readings implying a gigantic hit.^[i]

One reason November’s composite readings aren’t as bad as that, in all likelihood, is because economic activity hadn’t yet recovered fully from lockdown. Businesses are falling off a lower base. But also, businesses and households have learned a few lessons about how to adapt. Headlines have been warning about an autumn/winter lockdown since before the springtime lockdown ended, giving society time to plan and adapt. Non-essential retailers have boosted their online presences. Pubs and restaurants have improved their takeout operations. Also helping matters, most European nations’ schools remain open, keeping parents in the workforce full-time. Lastly, whereas European governments were playing catch-up when it came to passing assistance measures last time, they were able to enact new restrictions and assistance simultaneously this time, helping ease a bit of the pressure on the people and businesses most affected. All of these silver linings have helped mitigate the impact so far.

We encourage you to keep this in mind as more restrictions take effect in the US. Flash PMIs here all accelerated in November, to 56.7 (manufacturing), 57.7 (services) and 57.9 (composite).^[ii] Considering New York and the West Coast didn’t begin clamping down on activity again until late this month, it is probably reasonable to expect November’s positivity to be temporary. Contractionary readings in December or later this winter wouldn’t surprise. But stocks still appear to be looking much further out, with each development on the vaccine front enabling them to better see a future where activity is back to normal. Take any forecast like this with a grain of salt, but UBS’s number crunchers project that if vaccines roll out quickly (inoculating 35% of the global population), it could speed the recovery and help global GDP grow 6.3% next year and 5.3% in 2020.^[iii] Now, any projection claiming precision down to the first decimal point is probably a little far-fetched, but the general point is sound enough: When normal life can resume, economic activity can snap back very quickly.

Overall, we think stocks look about 3 – 30 months ahead. Early in a bull market, we think they look at the far end of that range. So in our view, markets remain near new highs not because they are ignoring the risk of contraction in the very near term, but because they can see the recovery that will follow that contraction. They have had months to deal with the prospect of a second wave. To say that risk isn’t incorporated into prices already is to say markets aren’t efficient and have somehow ignored eight months’ worth of headlines. In our experience, that just isn’t how markets work.

So keep an eye on data, PMIs or otherwise. Take note of how people react to it. But do so with an eye toward measuring sentiment and how it squares with how things are likely to shake out over the next couple of years, not with an eye toward predicting stocks in the near term.