What markets to watch amid continued PMI decline

PMIs are on the decline, and with this valuable tool likely to influence valuations in both stocks and FX, it is worthwhile noting which markets to target.

Chart Source: Bloomberg

Last year saw a huge decline for purchasing managers index (PMI) surveys across the board throughout much of the globe, with the noticeable slowdown in economic growth and business confidence driving a year of stock markets losses. The PMI surveys are of particular note due to their predictive nature, meaning that they are typically a leading indicator as opposed to the likes of gross domestic product (GDP). GDP growth is the primary form of growth measurement, yet the lagging nature of the release means that markets will have moved by the time they are released. However, it is worthwhile noting the accompanying notes that come alongside PMI surveys from Markit, with each providing an updated GDP growth prediction given the clear linkages between the survey and the ultimate growth figure that quarter.

Part of what makes the PMI surveys so valuable is that they are both qualitative and quantitative, meaning that the purchasing manager can provide a view of how things are currently and the direction of business. This gives the surveys huge value for traders, with rising or falling PMI surveys highlighting future shifts in growth, employment, and business. With that in mind, it is worthwhile noting the linkages that are typically seen between the PMI surveys and the underlying markets for that economy.

The UK services PMI and GBP/USD is one such pair of markets where you have a close correlation. Both markets peaked out in 2014 following years of consolidation, with a subsequent leg lower for both markets highlighting the close ties they enjoy. This means that traders should keep a close eye on the services PMI as a signal of where the GBP/USD pair moves from here. We also saw a downturn in the fourth quarter (Q4) of 2018 for both GBP/USD and the services PMI. Interestingly for the UK, the fact that the headline stock market is so internationally focused means that the FTSE 100 is inversely correlated with the pound and thus less correlated with the PMI indicators.

Eurozone

European PMI surveys have declined throughout 2018, with the manufacturing PMI in particular taking the hit amid a breakdown in trade relations with the US. The dramatic decline in the manufacturing sector was highlighted through a huge one-year decline from 59.6 to 51.4, December-to-December. The disproportionately larger impact on manufacturing in comparison with services highlights the impact US President Donald Trump’s policies have been making in the eurozone. As such, the manufacturing PMI survey for the eurozone is the one that truly tells a story of the direction the region is heading in.

Unlike the FTSE 100, markets such as the CAC and DAX are more domestically focused, and thus exhibited a positive correlation. This is exhibited clearly when comparing the manufacturing PMI, EUR/USD and DAX. All three are clearly correlated, yet with the euro and eurozone stocks taking their lead from the economic calendar, it is worthwhile noting that the leading PMI indicator is going to be a crucial tool for traders who seek to understand the future direction of the euro, and eurozone stocks.

US

The US markets have proven to be somewhat removed from the PMI picture, with the globalised nature of the dollar proving key to dragging the value of the greenback away from simply providing a close reflection of the US economy. We have seen a similar decline in the US PMI figures over recent months, yet this hasn’t had a huge reflection on the value of the US dollar. Yes, we have seen the US markets taper off, yet for the most part, much of the price action in US markets has been dictated by issues such as Trump’s tax cuts over recent years.

Thus, the PMI surveys provide less usefulness when it comes to US markets compared with in the UK or eurozone.

Conclusion

Ultimately the fact is that markets will react to news when it comes, and thus traders should be on the lookout for potential shifts in the pathway of each relevant PMI figure as a leading indicator of where we go now. As highlighted in Europe, each region will be more reactive to its own specific industry, with the UK sensitivity to the services survey standing in stark contrast to the eurozone’s manufacturing sector interest. The image below highlights the pathway we have seen for these three economies, with the second half of 2018 in particular showing steep declines for their respective PMI surveys. This has come alongside the market sell-off, highlighting the link that often occurs. However, it is worthwhile keeping an eye out for future developments as a gauge of where markets go from here.

PMI chart

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