Overall it’s been a solid week of data from the U.S. where business sentiment in concerned. ISM released their highly anticipated business surveys for September this week, with both manufacturing and non-manufacturing (services) pushing firmly higher.
Talk of tax reform, regardless of whether they arrive or not, also helped to boost sentiment towards the U.S. and take the edge off an otherwise underwhelming year here economic data is concerned. We recently highlighted that the CESI (Citi Economic Surprise Index) suggested data was being low-balled by the consensus, and perhaps ISM may turn out to be just one of the data sets that surprises to the upside over the coming quarter/s. That is not to say the data will be strong, but simply higher than some have anticipated.
As it stands, ISM manufacturing is now expanding at its fastest rate in over thirteen years and non-manufacturing in over 12 years. This suggests a broad expansion for the U.S., which comes as a welcomed surprise for economists and markets, as expectations of growth potentially translates to higher earnings and share prices.
Furthermore, that new orders are also rising sharply higher suggest future demand for business and a potentially higher headline PMI. As the ISM surveys are considered leading indicators for the U.S. and global economy, new orders can be seen as a leading indicator for the PMI itself. We also note the rising prices index as this highlights the higher prices manufacturers are paying for raw materials, which suggests inflationary pressures are building at the lower end of the value chain. But then this should also not be too surprising given the rally in commodity prices this year.
The reason ISM manufacturing is so closely followed is that it shares a relatively strong correlation with GDP. If traders suspect growth will be higher it can have a bullish effect on the stock markets. We’ve combined the manufacturing and service PMI’s and displaced +6 months to show the leading quality of the surveys. It is far from perfect but has been known to lead turns of GDP by 6-12 months and, if the correlation holds true, higher growth could be assumed early 2018 onward.
If traders are to believe the ISM reads and that stronger growth is around the corner, they may decide to express this by bidding the S&P 500 higher, even though it is at record highs. If we are to look at the sector rotational model we wrote about recently, this would suggest we are only midway through a bull-run. Of course, only time will tell, but fundamentally the picture may support stocks at record highs despite the relatively high valuations.
A Caveat
There is of course a major caveat with business surveys, in that they do not represent the entire economy. Despite the rosy outlook from the business side, the same cannot be said for the consumer side. With wages remaining soft, delinquencies beginning to rise and forever growing elephants in the room no one dare discuss (student and car-loan crisis?), there are growing concerns that the U.S. could be headed for a recession in spite of how optimistic the business side now appears. Even if inflationary pressures are building for manufacturers, there’s no certainty they will pass these onto the consumer, or if consumers would be willing to pay higher prices if they did. So until we see a pickup with inflation, the Fed are likely to remain on a gradual trajectory higher at best.