ISM Leading or Lagging

Now that the US manufacturing ISM survey has finally succumbed to contraction territory (sub-50) already seen by the Purchasing Managers’ Indices (PMIs) of the eurozone, Germany, UK and China, we await further declines in the survey as well as a confirmation in services survey.

The trend remains down especially as the latest Philly Fed survey fell to -16.6 (lowest since August 2011), latest Empire State Manufacturing survey dipped to 2.3 (lowest level since November 2011) and last week’s release of the Chicago PMI hit 52.9 (just above prior month’s 32-month low).

Lagging ISM Effect?
The latest sub-50 decline in manufacturing ISM could well be reversed for a few months before we see a renewed and deepening fall. This happened in January 2007, nine months before equities peaked out. That year, services ISM did not fall below 50 until January 2008, at the same time the Philly Fed entered negative territory. Manufacturing ISM found its sub-50 figure again in December 2007. Meanwhile, Fed’s Empire survey (NY PMI), fell below zero in February 2008.

Bottom Line Instead of comparing the varying timings of ISM declines and stocks’ peaks, there is a more evident and vital dynamic at hand. Today, global manufacturing and services PMIs are at markedly lower levels than they were in autumn 2007—during the record highs in US and G3 equities. These indicators are down by about 20-30% from their highs in spring 2011.

This implies that the impact on economic growth has already been transmitted, hence, the easing policies undertaken by all global central banks.

If the services ISM (due Friday) confirms the contraction in manufacturing this month or the next, then it would help ascertain that he peak in equities is already behind us, and that any rebound in stocks may not extend beyond the April highs.

If on the other hand, the services ISM does not immediately confirm manufacturing’s contraction (as was the case in 2007-8 when services contracted 11 months later), then there is hope for equities to lift further for 3-4 months, until the eventual contraction/convergence (in both ISMs) is established.

One thing is near certain: As we move father in time, both equities and US employment (Non-farm payrolls) will begin converging (lower). Since markets did not find Operation Twist (sterilized QE) to be sufficient in alleviating last year’s Oct-Dec volatility, they surely will not find a shortened Operation Twist to be sufficient.

Today’s US dollar bounce despite dismal US data may be resulting from the market realization that shortened and sterilized QE (Operation Twist) will be inadequate in addressing the unavoidable deterioration in business activity. This would trigger a falling equities and an accompanying boost in the greenback for as long as outright QE remains locked.