What Does The Manufacturing PMI Tell Us About Forward Stock Returns?

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When you think about all the articles being written about shortages and fears of inflation, it seems like the US economy is doing very well. You can’t really have those things without consumer demand. Indeed, some are calling for GDP growth of 8% in 2021 and a big increase in inflation.

I’m a little cautious on the GDP growth in 2021 causing sustained inflation (mainly because its high growth lapping a year that was beaten down) (as I previously wrote about). Let’s not confuse a one-time increase in prices with inflation…

But I also get pretty cautious when everything I read is all the same – “a boom is here.”

One piece of data that gets thrown around is ISM Manufacturing PMIs. The latest reading was 64.7%! It’s well above pre-COVID levels.

As they say on their website:

A Manufacturing PMI® above 43.1 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the March Manufacturing PMI® indicates the overall economy grew in March for the 10th consecutive month following contraction in April 2020. “The past relationship between the Manufacturing PMI® and the overall economy indicates that the Manufacturing PMI® for March (64.7 percent) corresponds to a 6.2-percent increase in real gross domestic product (GDP) on an annualized basis,” says Fiore.

Now, a PMI is a “purchasers managers index” and is basically a survey from a wide array of companies in manufacturing in the US. It basically is asking, “are you growing or shrinking?” across a wide array of topics.

Investopedia says, “when the index is rising, investors anticipate a bullish stock market in reaction to higher corporate profits.”

Actually – it can really be used as a CONTRA indicator.

I went back through the data to 1960 and checked the 6-month, 12 month and 18-month S&P500 returns after the manufacturing PMI was at certain levels. It’s not perfect, but its something.

I’ll just put the data out there – would you rather swing hard with the index around 65? Or below 43? There aren’t many cases when it goes above 70, but that generally does not have a good track record.

Look, I try not to market time. I’m typically nearly-fully invested. But I also understand there’s a time to own some names (e.g. cyclicals) and time to eh… maybe cool it and wait for a better day.

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