The Predictive Power of PMIs

Our head of Corporate Credit Research explains why the Purchasing Manager’s Index is a key indicator for investors to get a read on the economic outlook.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape, and how we put those ideas together.

It's Friday, March 1st at 2pm in London.

A perennial problem investors face is the tendency of markets to lead the economic data. We’re always on the lookout for indicators that can be more useful, and especially more useful at identifying turning points. 

And so today, I want to give special attention to one of our favorite economic indicators for doing this: the Purchasing Manager Indices, or PMIs. And how they help with the challenge that economic data can sometimes give us.

PMIs works by surveying individuals working in the manufacturing and services sector – and asking them how they’re viewing current conditions across a variety of metrics: how much are they producing? How many orders are they seeing? Are prices going up or down? These sorts of surveys have been around for a while: the Institute of Supply Management has been running the most famous version of the manufacturing PMI since 1948.

But these PMIs have some intriguing properties that are especially helpful for investors looking to get an edge on the economic outlook.

First, the nature of manufacturing makes the sector cyclical and more sensitive to subtle turns of the economy. If we’re looking for something at the leading edge of the broader economic outlook, manufacturing PMI may just be that thing. And that’s a property that we think still applies -- even as manufacturing over time has become a much smaller part of the overall economic pie. 

Second, the nature of the PMI survey and how it’s conducted – which asks questions whether conditions are improving or deteriorating – helps address that all important rate of change. In other words, PMIs can help give us insight into the overall strength of manufacturing activity, whether that activity is improving or deteriorating, and whether that improvement or deterioration is accelerating. For anyone getting flashbacks to calculus, yes, it potentially can show us both a first and a second derivative.

Why should investors care so much about PMIs?

For markets, historically, Manufacturing PMIs tend to be most supportive for credit when they have been recently weak but starting to improve. Our explanation for this is that recent weakness often means there is still some economic uncertainty out there; and investors aren’t as positive as they otherwise could be. And then improving means the conditions likely are headed to a better place. In both the US and Europe, currently, Manufacturings are in this “recently weak, but improving” regime – an otherwise supported backdrop for credit.

If you’re wondering why I’m mentioning PMI now – the latest readings of PMI were released today; they tend to be released on the 1st of each month. In the Eurozone, they suggest activity remains weak-but-improving, and they were a little bit better than expected. In the US, recent data was weaker than expected, although still showing a trend of improvement since last summer.

PMIs are one of many data points investors may be considering. But in Credit, where turning points are especially important, it’s one of our favorites. 

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