Global stocks are struggling to get out of a bearish stranglehold, investors in mature-market bonds are having a field day and the Baltic Dry Index, widely watched by economists as an indicator of global trade, has collapsed.
Prominent economists are forecasting a significant deceleration of global economic growth and even double-dip recessions on the back of severe cuts in government spending and tax increases in some European countries as a result of huge budget deficits.
Yes, you may well ask whether doom and gloom are our destiny.
Let us consider the current global economic environment. The main focus at this stage is on the European economy. That economy is holding up stronger than generally expected and although the GDP-weighted PMI was somewhat lower than for the previous month, the measure continues to point to an economic expansion in the euro zone. The Markit Manufacturing PMI for the euro zone in June came in marginally lower than that of May, measuring 55.6% compared to 55.8%, while the Services PMI dropped slightly to 55.5%.
The manufacturing industry in Italy, which is suffering from severe debt migraine and is the most worrisome country in the economic zone, managed to expand at a faster rate, with the Markit Manufacturing PMI rising from 54.0% to 54.3%, citing improving conditions in key export markets. The Markit Services PMI, however, declined from 53.7% to 51.5% but still signals expansion.
In Ireland, the other problem child of the European Union, the NCB Republic of Ireland Services PMI rose at the fastest pace since October 2007 from 52.4% in May to 55.4% in June.
Growth in Germany’s economy continues unabated with both the Markit Manufacturing PMI and Services PMI remaining unchanged at 58.
.4% and 54.8% respectively. The manufacturing sector is under strain as the backlog is leading to high levels of unfinished goods and upward pressure on capacity utilisation. New export orders have slowed, though.
In France, growth in the manufacturing sector has eased somewhat, with the Markit Manufacturing PMI at 54.8% compared to 55.8% in May. Albeit slightly weaker than May’s 61.4%, the Services PMI remains elevated, with the PMI at 60.8%.
The GDP-weighted PMI of the euro zone leads the GDP growth in the economic zone by approximately one quarter and indicates that the economy in the second quarter has grown by between 1.5% and 2% on a year-ago basis.
Sources: Markit; Dismal Scientist; Plexus Asset Management.
Regarding the immediate outlook, the IFO (business expectations) for Germany indicates that although the euro zone GDP-weighted PMI will be slightly lower in July it is likely to remain significantly above the 50-level, indicating continued expansion.
Sources: Markit; Dismal Scientist; Plexus Asset Management.
Economic growth in China, the pivot of the global economy, slowed somewhat as the CFLP Manufacturing PMI fell from 53.9% to 52.1% in June. The Manufacturing new orders and new export orders indices fell by 2.7 and 2.1 percentage points respectively from the previous month’s 52.1% and 51.7%, indicating slowing domestic and global demand. The CFLP Non-manufacturing PMI also receded from a staggering 62.7% in May to 57.4%. The construction and producer services industries are particularly strong, with the New Orders PMI indices at 64.9% and 57.2% respectively. Road transport, real estate and residential services are contracting, though. New export orders in the non-manufacturing industry pulled back slightly from 53.8% to 52.9%. The European debt crisis and tightening measures to cool the real estate market are therefore gradually unfolding in China’s economy.
It is evident that China’s GDP-weighted (manufacturing and non-manufacturing) PMI points to year-on-year GDP growth slowing to the 10–11% range in the second quarter of this year. (Since writing this post, a growth figure of 10.3% was announced.)
Sources: Li & Fung; CFLP; I-Net Bridge; Plexus Asset Management.
In the US the expansion in the non-manufacturing sector slowed somewhat in June as the ISM PMI dropped to 53.8% from May’s 55.4%. A similar trend was evident in the manufacturing sector where the PMI fell from 59.7% to 56.2%. The non-manufacturing sector was particularly weak, with both new export orders and imports contracting.
The GDP-weighted Export Orders (manufacturing and non-manufacturing) PMI contracted for the first time in four months as the index fell from 55.5% to 49.9%, while the GDP-weight Imports PMI fell to 49.98% from 56.5% the previous month. Although on a GDP-weighted basis the PMI for New Orders (manufacturing and non-manufacturing) dropped from 59.1% to 55.4%, it still points to expansion in the US economy albeit at a slower rate. Jobs continue to be created in the US economy despite a slight contraction in the non-manufacturing sector in June as continued expansion in the manufacturing sector takes up the slack. On a GDP-weighted basis the Employment PMI (manufacturing and non-manufacturing) slid from 52.6% to 51.6%.
The overall GDP-weighted PMI for the US in June was 54.4%, 2 percentage points lower than a month ago. Indications are that the real economy in the second quarter of this year was approximately 3–3.5% higher than the same period a year ago.
Sources: ISM; I-Net Bridge; Plexus Asset Management.
In Japan the Nomura Manufacturing PMI in June was slightly lower at 53.9% compared to May’s 54.7%. The PMI for new export orders declined for the second successive month, while shipments also declined. China continued to be the key source of demand. However, the services sector continues to contract as the PMI slipped from 47.5% to 47.1%. Indications are that the Japanese economy grew by approximately 3% in the second quarter compared to the same period a year ago.
Sources: Markit; Dismal Scientist; I-Net Bridge; Plexus Asset Management.
In the UK the Markit/CIPS Services PMI was down one percentage point at 54.4% in June but continues to signal solid expansion in the UK services sector. However, business confidence went for a loop as it recorded the worst fall in the 14-year history of the survey. The UK’s Manufacturing PMI drifted slightly from 58% to 57.5% but continues to indicate a strong expansion.
The GDP-weighted PMI (manufacturing and services) in June dropped 0.9 percentage points to 55.3%. Indications are that the UK economy grew by approximately 1% in the second quarter compared to the same period last year.
Sources: Markit; I-Net Bridge; Plexus Asset Management.
From the global manufacturing and non-manufacturing PMI statistics it is clear that the full impact of the debt crisis in the European Union and austerity measures are not yet apparent. It is therefore extremely difficult to ascertain how the global economic scenario will play out in the coming months.
Before drawing conclusions, let’s consider the performance of the Baltic Dry Index in more detail. The Index measures changes in the cost to transport dry bulk commodities and is seen by many economists as a leading indicator for growth. Why did the Baltic Dry Index fall to such an extent over the past two months?
Firstly, China’s Manufacturing PMIs for New Orders and New Export Orders tend to lead the Baltic Dry Index by approximately one month.
Sources: Li & Fung; I-Net; Plexus Asset Management
Sources: Li & Fung; I-Net Bridge; Plexus Asset Management.
The lead is due to the fact that an increase in orders leads to ships being booked to increase the stocks of major inputs.
Sources: Li & Fung; I-Net Bridge; Plexus Asset Management.
The recent drop in shipping rates can therefore be attributed to a reduction of stocks of major inputs in China’s manufacturing sector.
Sources: Li & Fung; I-Net Bridge; Plexus Asset Management.
The fall in the Baltic Dry Index over the past two months is probably due to a reduction in new orders and therefore a cut in stocks of major inputs. Although the curbs enforced by China’s authorities to prevent speculative real estate investment are probably the main driving force behind the reduction in new orders, a falloff in US imports is also rubbing off on China’s new export orders.
Sources: Li & Fung; ISM; Plexus Asset Management.
Also, the decision to allow the yuan to float more freely has probably resulted in China’s importers holding off on imports in anticipation of lower import prices due to the expected strengthening of the yuan against the US dollar.
The reduction in stocks of major inputs has led to lower commodity prices. Current levels of the Economist Metals Index suggest that the Manufacturing PMI for stocks of major inputs fell further in July, confirming the fall in the Baltic Dry Index.
Sources: Li & Fung; I-Net Bridge; Plexus Asset Management.
All in all it is likely that China’s Manufacturing PMI in July will come in somewhat lower than that of June. The same is likely for the Non-Manufacturing PMI as the Non-manufacturing PMI for New Orders broadly tracks that of the Manufacturing PMI.
Sources: Li & Fung; CLFP; Plexus Asset Management.
Will the lower PMIs and Baltic Index indicate a new trend – that of a weakening Chinese economy? Not necessarily. Firstly, beware of the seasonal factors.
China’s Manufacturing PMI tends to move lower from May to July and the current weakness is therefore no surprise. All other things being equal, the PMI could be expected to recover towards the end of the third quarter.
Sources: Li & Fung; Plexus Asset Management.
That is unless global demand falls away as it did in 2008.
Sources: Li & Fung; Plexus Asset Management.
It should also be borne in mind that the rise in the Baltic Dry Index toward the end of last year, the drop that followed in the first few months of this year, the rise through end May and the subsequent drop afterwards, all coincided with movements in the China Coastal Bulk Freight indices for grain and coal.
Sources: Chineseshipping.com
The crude oil and metal ore freight indices have been virtually unchanged since the end of last year. It seems as if the seasonal effect of China’s Manufacturing PMI can be ascribed to seasonal food and energy requirements and especially grain and coal.
In contrast to bulk freight rates, the Shanghai Containerised Freight indices tell a totally different story. Containerised freight rates on the North American route have jumped since the end of April, while those of the European route have started to pick up of late.
Sources: I-Net Bridge; Plexus Asset Management.
Is the market reading too much in the Baltic Dry Index with seasonal grain and coal demand having such an effect? I think so.
But what about the prospects for the US economy – will the downtrend in the ISM Non-manufacturing PMI continue and deepen? The ISM Non-manufacturing PMI narrowly tracks the Federal Reserve’s Senior Loan Officer Survey’s Net Percentage of Domestic Respondents Tightening Standards for C&I Loans (please note that the axis is in reverse order on the graph). Therefore the question to be asked is whether banks will tighten their lending standards in the coming months. I doubt it, as the Federal Reserve Board is committed to keeping interest rates low, especially in the light of the uncertainties regarding the fallout from the European debt crisis.
Sources: ISM; Federal Reserve Board; Plexus Asset Management.
In summary then, unless the European debt crisis worsens and austerity measures force some countries into depression:
• China’s Manufacturing and Non-manufacturing PMIs will remain under pressure over the next month or two but will rebound significantly towards the end of the third quarter.
• The Baltic Dry Index is likely to start to recover towards the end of August.
• Metal prices are likely to start to recover soon.
• US ISM PMI indices are likely to improve significantly towards the end of the third quarter.
Investment implications:
• Mature-market bond yields have probably seen their best and are likely to rise strongly.
• The risk of investing in emerging-market bonds and equities is likely to decrease as global investors’ risk appetite increases.
• Commodity stocks and especially metal stocks are likely to outperform.
• Emerging-market currencies and the euro are likely to strengthen against the US dollar.
From Fav Stocks published on 07/18/2010 – 1:31 am PDT