Global PMI Data for June Show the Contraction is Spreading
A flood of manufacturing PMI reports hit the markets on Monday – luckily for the growing herd of bullish punters (more on that further below), the markets were still delirious over the euro-group summit (it almost sounds like a bad joke to say that). Otherwise these reports may have met with a more sober reception. As it is, we are under the impression that markets are trying to game the next round of central bank pump priming, which is expected to start this week with an ECB rate cut and a further increase in 'QE' by the Bank of England (they're presumably going to do this because the previous rounds have worked so well). The biggie will of course be the Fed once the vaunted 'incoming data' become even more troublesome.
Below we list the PMI headlines with links to the reports (all except US ISM are in pdf format):
JPM Global Manufacturing PMI:
US (Markit PMI):
The ISM came in at 49.7, way below the as usual over-optimistic expectations of economists. Apparently they have convinced themselves that the US economy is somehow isolated from the world. As we have pointed out many times, such 'decoupling' theories are nonsense. The reality is that there are slight leads and lags between the economic cycles in various countries. The high degree of economic interdependence in the modern-day world is easily discernible when comparing the performance and trends of various stock markets. As it were, the technical non-confirmations created by the aforementioned lead-lag phenomenon – this is to say, the fact that market peaks in different markets lately don't tend to occur simultaneously, but are spread out over a period of several weeks and sometimes months – is considered an especially ill omen by technical analysts.
UK Construction PMI:
The Euro Area PMI reports were not surprisingly an unmitigated disaster:
Greece: (it's a small miracle there's still something left that can contract)
Euro-zone joblessness: unemployment rate at 11.1%, a new all time high
Unemployment in the euro area and the EU 27 hits a new high since the introduction of the euro – click chart for better resolution.
Within the euro area, variations in unemployment rates are remarkably high, ranging from 4.1% in Austria to 24.6% in Spain.
Well, you get the drift – it is beginning to look like a synchronized global recession is indeed getting underway.
What Are the Markets Discounting?
One could well argue that the collapse in stock prices in the European periphery over the past year or longer already reflects the economic downturn to a large extent. However, we believe it would be a grave mistake to underestimate the staying power of this particular bear market.
We are far more concerned that many stock markets in the world have not yet seen similar declines, while the economies concerned – with the US economy the most pertinent example – appear on the verge of weakening noticeably.
Let us not forget that ECRI continues to forecast a recession to begin in 2012 (whereby the definition of a recession is not merely 'two quarters of declining GDP', and not only because GDP is a useless statistic. A recession is better defined as a contraction in economic activity on a broad front).
The chart below compares the S&P 500 index to the IBEX in Madrid. The point we wish to make here is that in recessions and during times of tightening monetary conditions, stock prices tend to fall. It goes without saying that the SPX is at present by no means discounting the rising probability of recession.
The S&P 500 compared to Spain's IBEX – after correlating closely during and shortly after the GFC, the two indexes have drifted far apart - click chart for better resolution.
We are also beginning to wonder about the recent plunge in the CCI-SPX ratio (the CCI is the 'old' CRB, the unweighted continuous commodity index. The CRB contains a huge overweight of energy nowadays, so that changes in the oil price have an exaggerated effect on the index. We think the unweighted index captures the developments in raw materials prices as a whole better, as the oil price is frequently driven by geopolitical considerations).
There is of course nothing that says that commodities must move in the same direction as stocks all the time. During the 1990's commodities were in a pronounced bear market, while stocks soared. However, since 2002 the two sectors have been almost joined at the hip, mainly due to perceptions regarding the growing demand for commodities from China. It follows that a decline in this ratio is a strong warning sign that China's economy is probably weakening more sharply than people have hitherto been prepared to acknowledge.
The CCI-SPX ratio – commodities have plummeted relative to the stock market - click chart for better resolution.
Although the Shanghai stock index is not a very informative gauge per historical experience – not least because it is dominated by state-owned firms – it is noteworthy how persistently weak it has been over the past three years:
The Shanghai Composite has been mired in a bear market since its post bubble rebound high in 2009 - click chart for better resolution.
It appears to us that the main thing holding a number of markets up are the hopes for more 'QE' from the Federal Reserve, with looser monetary policy from the ECB and the BoE running a distant second and third on the hopers' list.
Perhaps another weak unemployment report later this week will tip the balance toward to 'doves' and indeed result in another round of monetary pumping. The greater risk for bulls in the near term is however that it won't, given the exigencies of an election year and given the fact that the US stock market remains quite sanguine at this juncture. A strong political fig leaf will be required for the Fed to act.
It is ironic in this context that analysts far and wide have assured us for well over two years that China's planners will 'ease at any moment now' and that therefore, a 'hard landing' in China was not possible. Well, they have finally begun to ease in reaction to what increasingly does look like it could become a 'hard landing'. And yet, anyone buying Chinese stocks on such forecasts had their head handed to them (when searching our PC for an old report about 'China Risks', we ironically came across one from May 2011 entitled: “US demand weak, but upside risks from China"). This is a warning worth heeding when considering the widely hoped for monetary largesse thought to be imminent from other central banks.
Meanwhile, Mark Hulbert notes that the recent market rebound has already made stock market timers more bullish than they were at the April top (respectively the May top in terms of the DJIA) – a very ominous divergence:
“An unusually large number of stock market timers spent the weekend jumping on the bullish bandwagon. And that’s worrisome from a contrarian point of view.
That represents a 24 percentage point jump from the 22.7% level where this average stood as recently as late last week.
Particularly disturbing is that the HSNSI is now higher than where it stood on May 1, when the bull market that began in March 2009 hit what so far is its highest closing level. It’s five percentage points higher, in fact, even though the Dow is more than 400 points lower today than then.”
It should be pointed out that the HSNSI is not the be-all and end-all of contrarian analysis. It is merely one data point of many, and not all are as stretched as this one, although overall, there are signs that the market is now overbought in at least the short term (for instance, option traders have also become quite optimistic of further gains). One should also not forget from a technical perspective that the decline in the SPX from the April high was an impulse wave. Hence the current rebound has a high likelihood not to exceed this high and be the prelude to a far steeper decline once it concludes (this view would be invalidated if the market indeed managed to rise to a new closing high).
Addendum: Happy Independence Day
We wish our US readers a happy 4th of July. Don't forget, the man who probably best represented the ideals of the revolution was Thomas Jefferson. We highly recommend the Jefferson biography by Albert Jay Nock (free pdf) for reading in this context – Jefferson would no doubt be aghast at the Leviathan the Federal Government has become. In fact, he would likely be aghast at a great many things. At several points along the way a few wrong turns have been taken.
“I like a little rebellion now and then,” Jefferson wrote Mrs. Adams, “. . . The spirit of resistance to government is so valuable on certain occasions that I wish it to be always kept alive. It will often be exercised when wrong, but better so than not to be exercised at all.”
Thomas Jefferson, the founding father we like best.
(Image via Wikimedia Commons)
Thank you for your support!
In case you prefer to donate bitcoins, the address is: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
Follow us on Facebook!