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Economy in Brief

Composite PMIs Show Mostly Strength, But That's Not the Whole Story
by Robert Brusca  February 5, 2018

The PMI readings are one of the biggest reasons for optimism on global growth. A look down the column on the far right of the table (below) shows how high the individual Markit PMI readings rank among their own data back to January 2013. Data for the EMU overall, Germany, France and Italy show exceptionally strong readings on all these metrics. Spain has fallen off the super-strong bandwagon and even has a services sector that is now steadily losing momentum in terms of its sequential average readings (although for Spain, January shows some 'renewed' life).

The U.K. shows very steady PMI readings, but for the UK these are very low readings as the economy is generating a composite index that is in the lower 20th percentile of its queue of data since January 2013. Japan has a solid-to-strong manufacturing sector reading and this month its services sector ticked higher to more like a 67th percentile standing.

China shows moderate PMI raw indexes. But China has been so weak for so long these reading translate into relatively high queue standings since January 2013 and these exaggerate China's strength. At 51.5, just one and one points above neutral, the China manufacturing reading has a top 12th percentile reading when measured against the queue of data from January 2013. The services sector at 54.7 has been higher only 1.6% of the time since January 2016. To generate a comparable standing, Italy has to log a composite or manufacturing reading of 59. The same is true of Germany. Germany needs a service sector reading of 57.3 to generate a standing of 98.4%. So China is generating this high relative standing, not because of growth that is strong in absolute terms but because it is doing better than it has over the last five years that have been disappointing years.

This brings us to the United States. The U.S. PMI data from Markit show U.S. readings with standings that are shockingly low compared to other places. And with everyone gushing about U.S. growth picking up, this may seem an anomaly. Indeed, on another application of U.S. data, the ISM indexes, the U.S. economy fares much better and is much stronger with stronger absolute diffusion readings and stronger rankings as well. But interestingly, if we rank U.S. employment change data over this same period, U.S. service sector job creation is weaker only 26% of the time leaving that real metric with about the same signal as that from the Markit readings. The U.S. ISM nonmanufacturing index, which matches closest with the Markit services PMI, stood at a moderate 56th percentile in December, but in January it has now popped up to a 59th percentile standing. January has snapped the ISM nonmanufacturing index out of its two-month funk and it is now back in alignment with its strong September and October readings. But which of these sets of data is real? Prior to November-December, the ISM nonmanufacturing index was in a 54 to 57 habitat all the way back to late-2015. Is it really going to hold remains at the level of 59 where it is in January and where it stood in September and October?

The services move is 'peculiar' because the U.S. services sector had been much weaker and U.S. service sector jobs growth has fallen to the lower quartile of its range since January 2013. Recent productivity readings have not been encouraging; it is not clear how the services sector gets - or keeps- traction on weakening job growth.

However, I have also presented findings showing that for the U.S. and the EMU, the PMI data in manufacturing have become somewhat disconnected and the actual IP data, that we care most about, are no longer tracking the strong PMI readings as they once did. Since PMI data are about breadth and IP data are about strength, it is not surprising that they disconnect from time to time. At this point, I think that the slow steady growth has been much better for breadth than for strength. Growth is not really building or mushrooming, but it has been persisting and stabilizing. In the U.S., at least labor force growth is still lodged in lower paying jobs. And despite all the talk about wage growth, if you look at the correct series in the employment report (average hourly earnings excluding supervisory personnel), you will find that AHE rose by 0.1% in January and by 2.4% over 12 months- there was no wage acceleration. The notion of accelerating wages came from reporters and other non-experts looking at the 'wrong series.' Still, wage growth is more uniform but also slow in creeping up. Most workers are seeing wages gain 2% and even 2.5% across many categories. Again, breadth is growing, but strength is slow in coming.

Globally, conditions are still weak with weakness the most pronounced in Asia. Note the chart above and the positioning of raw diffusion scores for China and Japan relative to Europe and even the U.S. which is losing momentum in the chart based on the use of Markit PMI data.

One 'interesting development' is the recent weakness in an important trade barometer, the Baltic Dry Goods Index. This well-known and solid barometer of global trade has been slipping steadily and that is not a good sign for global trade and growth developments. So far, the monthly index shows just a small step back. But this will be an important indicator to watch.

I have been much more wary and concerned about what global monetary policies are doing. By this, I mean that while many have been and are still cheering bankers on to suck out stimulus and to hike rates back to 'normal levels' I have been on the opposite sideline cheering for continued and very measured restraint or pause.

Assessments of growth I think have benefitted from a confluence of things that are not all real. The PMI data are exaggerated and do not link to growth as they did in the past. Retail sales in the U.S. benefited from disaster damage and the need replace destroyed property, some of it with insurance dollars. In the U.S., in January vehicle sales have sunk again back below the post hurricane-distorted trend. In the U.K., Brexit takes a toll and U.K. auto registrations are lower in January. In December, EMU retail sales fell showing their annual growth. In China, favorable comparisons with past anemic data make weak PMI readings seem much stronger than they really are.

Moreover, the conditions we have cannot be thought of as separated from the stimulus central banks are providing. It's a fair question to ask what would growth look like if all this stimulus were removed. We are on the verge of finding out. And the early evidence is not all that reassuring.

While I rarely write here about markets, the selloff in bonds and the accompanying drop in global stock prices are not good for either future confidence or spending prospects. I understand that stock prices have been stretched by some norms, but the fact remains that even if a selloff is needed to restore balance it will also adversely affect confidence. My own view of these events has been to see them as due to fears that policy is actually headed back to normalcy too fast. While the financial press is full of stories of rising inflation and US wage pressures, these things simply are not happening. Even the growth revival has at last as much fantasy and fiction as fact. Growth is broadening more than it is accelerating. Markets are pricing bonds to expected central bank actions. And since I do not see the underlying economic structure to support these sorts of changes, I think central banks will be forced to stop these actions and maybe not before it's 'too late.' Markets can discount what central banks do. And the effect of tightening is benign if the economy is strong and needs some restraint; but not so if the tightening is overdone. Right now neither inflation pressures nor growth are calling for a rate hike. Central bankers are hiking rates because they are so low and bankers are encouraged by growth. They want to get rates closer to normal. But isn't this the 'new normal?' So what the heck is normal here? Can we have 'old normal' rates with 'new normal' growth? I think we might be on the road to finding out. I think it's a dangerous road.

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