Flash PMI’s Turn in EMU

PMI Signals Are Lagging - PMI’s have lagged the pickup but they are near to neutral and the Markit overview index has reached the neutral mark of 50 in August. Markit’s overall PMI reading for the Euro Area rose to this neutral level of 50 in August lagging behind the GDP signals that in Q2 already turned up for two key E-Zone countries (Germany and France) and with the Zone’s own GDP barely falling. Purchaser indices that usually are more sensitive than other macro-data have not been leading in Europe and that is a point to ponder.

Large jumps in August play catch-up -- The jumps in the respective MFG and Services indices were large. For Services it is the largest jump in its history that extends back to mid-1998. For the MFG index it is the eighth strongest jump in a history that goes back to mid-1997.

Still, the fact that the big signal from the PMIs is lagging is a curiosity.

Thinking more about PMIs -- PMI indices are diffusion indices and formally they are indices of the breadth of change in a certain direction (up or down, greater or less) rather than of strength. The overall index is a weighted average of components that look at specific aspects of an industry getting diffusion responses on each. However, these indices are used as a proxy for strength since the correlation with ‘strength’ is high for ‘breadth’. Still we should bear in mind always that ‘strength’ is not in fact ‘breadth’, they are different things and sometimes the difference matters, even if most of the time it does not.

Viva la difference?? If you have never thought of the PMIs this way before, note that this concept has been long in play in analyzing trends in the stock market. The stock market index is a weighted average of stocks, an index that goes up and down, but technicians also look at indicators of ‘breadth’. And when they do, they DO NOT call them ‘strength’ but when breadth and strength go together a rally’s strength is said to be more powerful. Sometimes the market goes ‘up’ but decliners ‘outpace’ advancers. This is exactly the same thing as looking at output Vs its diffusion. Output and diffusion do not always go in the same direction. Manufacturing output is like the stock index and the MFG PMI is its breath measure. Services output is compared to the breadth of the services PMI. But in the case of our economic statistics we get the breadth reports much more quickly than we get the output reports and so the diffusion indices take on a life of their own and become proxies for ‘output.’

The diffusion difference - What the diffusion indices usually do, is to pick up small improvements that might be scattered around the economy and lost. Diffusion indices create a signal that would otherwise get lost in the aggregation of data with weighting always going to the largest of reporters. So this time around it seems that the opposite is happening. A few larger reporting firms are doing better and driving the macro -data higher while the smaller firms are not yet on board for the ride. This is not surprising with all the government intervention (…in Europe, the UK and the US, in fact) since government tends to work ‘best’ with big business. If the assistance works properly (or at all) stimulating output at the larger firms (like auto makers) should create some knock-on effects that will draw other firms into the upswing. And the PMI reports may be signaling that, in August, this is finally happening. But this process is a bit like trying to start a fire with wet wood on windy day. Just because you have gotten a spark does not means you will be able to nurse a bone-warming bonfire out of it. Still, with a spark, you have a chance. And there is some tentative evidence that growth is spreading- at last. Getting the diffusion indices on board is crucial – they remain important barometers of the success in spreading growth.