April 2nd, 2012
The ISM purchasing managers index can explain about 60% of the annual variation in U.S. GDP, with a margin of error that averaged less than half a percent during the last 10 years. Given the key role of manufacturing, even in the U.S. economy, dealers form expectations of world output directly from the multitude of PMIs, data on the last of which arrived in the last 36 hours. Dealers suggest the news from the world’s factory sector in March could have been better but it could have been worse and now they’re mapping the PMI results to their GDP tracking estimates.
In the quarter just ended, ISM PMI averaged 53.3, while in the last 12 months the index averaged 53.6. Using a 2001 set of calculations from U.S. Department of Commerce economist George McKittrick, the latest PMI annual average is consistent with a 4.0% rise in real GDP. Alternatively, annualizing the PMI for March corresponds to a 3.7% increase in real GDP annually. In both cases, the GDP growth rates associated with this reliable indicator are well above where Street economists or the Fed see full year 2012 growth in the U.S. economy.
With an ISM PMI estimate (53.5) that just missed the actual, Wrightson ICAP noted Monday, “The Fed’s industrial production data suggest that factory output grew even faster in the first quarter of this year than at the start of 2011, but the ISM factory survey hasn’t kept pace.” UBS Investment Research, who also came within a hair’s breadth* of nailing the result, echoed that sentiment by pointing out that manufacturing output growth is “running much stronger than suggested by the ISM index” since the ISM PMI measures the relative share of industries with rising output rather than unit output. UBS economists still expect the U.S. to eke out 2.3% real GDP growth (annualized) in Q1, which puts the dealer’s estimate between 30 – 50 pp ahead of the peer group consensus.
* Six of the primary dealers in the Reuters News poll had March ISM PMI estimates of either 53.3 or 53.5.
J.P. Morgan Securities says that its global PMI, also published today, presently suggests growth in worldwide industrial production “could turn fairly soft” in the upcoming quarter. The firm wrote Monday, “In addition to the relatively low level of the PMI’s production index, the new orders index has fallen the past two months, and its level is 1.6 points below the level of the production index. Also, the finished goods inventory index is relatively elevated, suggesting inventory growth is excessive in some countries.” JPM does not include the US in its global finished goods measure, though the firm anticipates “some inventory drag there” in the second quarter. The firm concluded, “All in all, the PMIs’ internal momentum is poor,” but offered optimistically, “Acceleration in final goods expenditures would change this dynamic. In fact, our consumption model predicts somewhat faster spending growth in 2Q, based on recent developments in labor markets, equity markets, and consumer prices. We also look for a pickup in business capital spending. If these forecasts are correct, this will register first in our final demand proxy (retail sales and capital goods shipments), and in the PMI new orders index.”
Conditionally calling for only a modest drift lower in global output in the second quarter, Credit Suisse Economics Research recapped the various countries’ factory surveys by saying, “All in all, March PMI reports continued to support our expectation that the potential downswing in cyclical momentum over the spring months will prove less frightening than last year’s slowdown scare. The improving level of activity in the US should help offset weakness elsewhere.” Taking note of the fact that Eurozone PMIs mostly improved for countries in the periphery but weakened in the core economies, CS nevertheless conjectured, “The resilience of domestic demand in the core euro area countries, especially Germany, is vital to the rest of the euro area, as it is likely to translate into increased imports from other European countries – where domestic demand is muted – thus helping weaker euro area economies. In this regard, we shall closely monitor if the periphery PMIs would weaken again following recent softening in the core euro area PMIs.”
Reporting a slight decline (from -0.31 in February to -0.37 in March) in its own aggregate global manufacturing confidence index, Barclays Capital hints at a spring pause in worldwide factory output. “We do not find this decline significant in light of the recent trend. This view is supported by the modest decline in the gap between new orders and finished goods inventories (from -0.61 in February to -0.66 in March), which we consider to be more of a leading indicator of the global industrial cycle. Nevertheless, at face value, the sluggishness in the index as well as the amplified volatility suggests that global industrial production is unlikely to resume an uptrend just yet; rather, it is still in a stabilization phase.”
Eighty percent of U.S. manufacturing industries surveyed in March reported higher activity than in February. As well, three of ISM PMI’s five weighted components increased between February and March; the employment component hit a nine-month high and the inventories component hit a six-month high. Remarking on the superlatives in these two components, Citigroup Global Economics ventured, “The overall ISM report shows slight maturing of the manufacturing production cycle in the U.S. but a reasonably solid ongoing performance, with few concrete warning signs ahead.” Bank of America Merrill Lynch US Economics called the latest ISM PMI “a solid close to the first quarter” but remains undeterred in its call for a pullback in Q2. BAML economists wrote, “The ISM index is essentially a growth momentum barometer. While manufacturing remains a constructive secular story, the ISM manufacturing Index likely will not be immune from our forecast of a second half slowdown.”
With the ISM PMI edging out the market consensus and printing above the 3- and 6-month trailing averages, economists seem more inclined to slightly upgrade their Q1 U.S. GDP tracking estimates. Likewise, having printed at 51.2 in both January and February, the 0.1-point dip in the J.P. Morgan Global PMI to 51.1 in March should still allow economists to add fractionally to their global GDP estimates. Nevertheless, the shifting dynamics of goods orders and production within individual countries understandably discomforts some dealers and the lack of widespread improvement in March PMIs leaves behind continued expectations of only modest global GDP growth in 2012.