Despite Spreading Covid-19, Global MFG PMIs Advance Strongly; But Beware the Future!

The graphic of the largest global economic regions shows that a powerful expansion is still in place in December. This is despite a spreading Covid-19 and a situation where lockdowns have intensified. But the impact of these lockdowns may in fact hit harder next month. These data are for the month when taboos were flaunted and social distancing largely eschewed by people gathering for the holidays (there's no place better to catch covid-19 for the holidays! No matter how far away you roam). The damage from that fiddle-dee-dee approach to health warnings is playing out more in January as Los Angles in the U.S. is being overwhelmed by cases to the point that ambulance drivers are being told not to bring some patients to the hospital (story) and where oxygen (story) is being rationed. The U.K. lockdown is severe and vacations for January are being cancelled (story). A German professor is warning that its lockdowns are too late (story). So rather than viewing the December data as evidence that economies have become resilient we will need to wait to see how this all plays out in January and maybe February when the impact of the ongoing lockdowns will bite; not while they only bark as they did in December when the warnings were not heeded.

Still, the December manufacturing data are impressive. The just released U.S. ISM manufacturing index is even stronger than its Markit counterpart. Among the 18 economic units featured in the table, only four decelerated in December and only two have readings below 50 indicating contractions – and both of those are barely below '50.' This contrasts with nine slowdowns in November and six contractions and with October's six monthly slowdowns and five contractions. However, December is not just part of an improving trend but a real step-up and a surprise in terms of extending trend developments.

I present below a lot of data to memorialize these trends. Bear in mind that some look at say, three-month changes and some look at change in three-month vs. six-month averages...and so on. These are different ways to assess the dynamics. No matter how the data are dissected, they seem strong, at least for now. The broader period averages show ongoing improvements with the most accelerations over six months compared to 12 months and with the recent three-month average giving back slightly. The percent of economic units improving (not base on averaged data) transitions from 94% over 12 months to 82% over six months and to 64% over three months. As the PMIs get higher, the percentage improving gets smaller but the sense of improvement becomes more entrenched despite the smaller breadth of gains because of the higher PMI values.

Since January 2016, there are four countries on new high readings in December: The U.S., Canada, Taiwan and South Korea. The U.K. and India also have exceptionally high readings. Only Mexico is below the midpoint of its high-low reading range. However, relative to historic median values, Mexico, France, Vietnam, Russia and Japan have values below their historic medians calculated back to January 2016.

Compared to January levels, the manufacturing PMIs are higher in all countries except Turkey and Mexico where the PMIs are lower on balance and France where the index is unchanged from its January level. There has been recovery from the Covid-19 pandemic, but output has been lost; and that lost output that has not been made up. There is a still-decimated service sector plus, globally, substantial stimulus still being provided by various aspects of fiscal policy as well as by monetary policy. Do not think that this report says that we have put Covid-19 behind us.

With various economic groupings at the bottom of Table Select Manufacturing PMIs, it is clear that most countries are recovering and that so far manufacturing is not being left behind for any group. The Asia average, however, is slightly weaker in its queue standing but not in its percentile standing and only modestly so in its average for December in comparison with other groupings.

The table below takes us on a different journey. There I have used logical operators to separate the PMI metrics according to how they are stratified across PMI diffusion values. The PMI results for average and recent months are displayed in the table grouped by the percentage distribution (the frequency distribution) in each diffusion cohort. To aid in understanding what these data mean, I have identified the periods at the table bottom in terms of the actual calendar-time parameters in addition to their designation of being three-month or six-month averages…and so on. The readings of the recent three months are really quite strong. The distribution of observations at 50% or above is stronger than for any of the past periods (this is not the same as saying it is higher than for any preceding three-month segment in those past periods). The 37% of observations in the 50 to 55% cohort is substantial, but well below the 62% in the period designated 12-month before that (which is 13 to 24 months ago and represents the full year of 2018). However, in the next strongest cohort the recent three-month period has 31.5% of its observations which well outdistances the 19% in 2018. And there are an add 5.6% in the top cohort over three months compared to 0.9% in the earlier 2018 period. The three-month period does have more observations is the below 50% cohort (all in the 40% to 50% range), but there is much more strength at the top to offset that.

You can compare the recent three-months, six-months or 12-months to those early periods to get a sense of how things stand. Even the current 12-month period that encompasses the full year of 2020 and all its covid-19 problems stands up well against the year before when trade issues were slowing things down but 2020 is much weaker than the readings for 2018.

The cohort approach allows us to see how the recovery is progressing across all counties given each equal weights in setting our view of the economic environment. However, the above analysis looks at the current period – only for manufacturing- and it grades out as quite solid, quite strong and with some countries underperforming but with no stragglers- at least not on this data set. Of course, an important caveat is that this evaluation is only for manufacturing and it is not in any way comprehensive as it sets aside unemployment and makes no allowance of the degree that monetary and fiscal policy have contributed to these outcomes. Regardless of that, compared to where conditions were in March and April globally, I think this is a remarkable set of results. Of course, there will be a price to be paid for all the government stimulus and there will be a price for all the dislocations especially in services. These will not spring back so easily. A lot of private sector capital has been wiped out. Careers and businesses have been destroyed. Entrepreneurs have been decimated. Yet, the most frequent warning you get in analysis for the year ahead is that an inflation impulse is likely…Why?

I brand this fear as the most unrealistic fear of 2021. This is a forecast from the folks that believe in mean-reversion. That is reference to the notion that inflation has been undershooting for a long time so not it is time for it to overshoot. Yet, we have no support for the idea that such symmetry is driving policy. Over the last eight years, the U.S. Federal Reserve ran policy under that 'fear' supported by a theoretical construct the Phillips Pancake...oh sorry the Phillips curve. But that curve had become a pancake and even so the die-hard Phillips-curve ballers continued to appeal to the small curvature on the surface of the pancake as something that they could drive policy by. When beliefs run that strong facts are not relevant… Eventually, however, the Fed threw out the Phillips curve along with its bellbottomed pants from the '60s. The Fed began a new policy regime in the wake of assessing life with and after Covid-19.

However, the Fed, having been on the wrong side of the inflation argument, does not mean it has now change sides and will be wrong again (the expression here is 'whipsawed'). It's possible, but not a sure thing. The view that sees some inflation ahead has some merit – as all bad forecasts do. Some asset prices are rising strongly housing, stock prices and now bitcoins. Treasury yields are rising; the Treasury curve is steepening…Some commodity prices are stirring too. Da, da, da da da da…(play the sound track from Jaws (here)…and there has been a lot of federal fiscal and monetary stimulus not just in one country but globally. However, that was not classical stimulus it is better labeled as fiscal sustenance since private incomes had – or would have- collapsed without it. It was not classical stimulus on top of normal demand. It was more like the cherry on top of the sundae except there was no sundae. So what do you call that?

Moreover, although PMIs a climbing to extended heights (in manufacturing at least) the service sector remains wounded and will be impaired for much of 2021- probably all of it. Not only is the virus circulating but we can see that the vaccination programs will have glitches. In addition, while some people will be ready to party after one shot, many others will remain guarded about public gatherings even after the second inoculation. Behavior is going to be changed and restrained for much of the year even if it gradually evolves back toward normal. And then there is all that economic damage I spoke of. In the U.S., at least there is liable to be a second wave of weakness when the support programs end and people will have to come to grips with their new financial circumstances without a fiscal backstop. Some are going to owe prodigious amounts of back rent. I don't know how they will pay it. Some may get evicted for missing mortgage payments. These tensions will take on different faces in different countries depending on the nature of the special support doled out during the crisis.

There is a lot of focus on how things have changed and how more people will work at home. They are the lucky ones. The amount of unemployment is still large. Future government support will (eventually??) be restrained by the huge size of federal debt. Not everyone can work from home. Some may not have jobs; some may not have homes…

The U.S. situation
On balance, this future does not seem very inflationary to me. Certainly in the U.S. there are Democrat party initiatives that could raise costs by imposing more regulations and by fast-tracking green objectives. Those pressures will come from the cost side, but the demand side still seems likely to be impaired to me. We don't know yet what Joe Biden will do with the existing tariffs. If he takes them off, there could be a countervailing pulse to lower prices. It seems unlikely that he would raise them further. High levels of unemployment and a decimated entrepreneurial class could make economic recovery in the U.S. much slower. There could be 'trust busting' action to go after large tech companies and that could create its own disruptions.

The internet is still as popular as ever and providing ongoing price discipline. There are some covid-19 related shortages that have boosted prices giving some credence to those who see inflation percolating up under every rock in the future. But those shortages are limited and it seemingly nearing an end. I do not look for inflation to rise more than episodically then to retreat. I do look for growth to be uneven. And think the period of adjustment ahead is not being properly evaluated as being the ongoing disruptive state it will be. Once the government is forced to step back, then the private sector will be forced to deal with the new economic reality on its own. Taxes will go up to pay for it –and not just on the rich. There is too much debt to think you can place them on just a few backs. Beware the future!

Cmmentaries are the opinions of the author and do not reflect the views of Haver Analytics.