Despite the countless hours spent by the media talking up the debt ceiling debates and its effects on financial markets the real concern amongst actual investors has been the prospects of actual economic growth. As we have stated in the newsletter as well as in previous posts on the blog we do not think, and bond yields have agreed, that anyone is actually scared of a default. So despite the misguided hand of the media bonds and other financial markets are moving based upon future growth potential or the lack thereof.
On Monday we got a PMI number that came in not just low but drastically lower than expected and very near the negative growth line. The PMI index is a diffusion index meaning that if it is above 50 then the manufacturing sector is growing and if it is below 50 then the manufacturing sector is contracting. So how bad was the number? Well last month PMI came in at 55.3 and this month it came in at 50.9 which means that manufacturing is barely above the zero line. You can see the drop more clearly by looking at the chart below. (Click on chart to enlarge)
As you can see the drop from the February peak reading of 61.4 has been fairly steady and swift as the manufacturing sector has been slowing down despite many economists expecting strength in the economy and a continued recovery. Of course as long time readers know we have been less than impressed with the economy ever since the bottom back in March 2009. The market rebound was impressive but the real economy has been very mediocre. All this has weighed heavily on the markets as of late and since February bonds have been moving higher. At the same time and with the help of he sideshow in Washington the stock market has taken a hard and swift hit as of late and is starting to get more in line with the actual economy.
One chart that we like to follow is that of the SP500 year over year growth rate overlaid with the PMI data. As you can see the PMI is a good rough business cycle indicator. While not perfect by any means it does a great job of tracking what the market is expecting in the medium term. As you can see right now the PMI is pointing lower and it seems as though stocks are following its lead. (Click on chart to enlarge)
PMI and SP500 YoY % Change
Right now many of our economic indicators are saying to lighten up if not exit equities all together. While this has been the case for a while the market via trend, breadth, and sentiment is coming around to the same conclusion, and that is that the economy is weak and prospects are not good for a favorable risk to reward environment. Do you really want to sit in a market hoping to eek out meager gains of maybe 5% over the next year but with potential and relatively likely downside of 15-20%? We don’t and instead have been going into assets that do well in times of slow economic growth.
Disclaimer-We are long US Treasuries via TLT and also hold some small long positions in US equities.