Surge In Sentiment Surveys
There is an interesting divergence going on between sentiment based surveys, specifically the ISM Manufacturing and Non-Manufacturing surveys, and actual underlying economic data. This week saw both surveys rise sharply to cyclically high levels despite weakness in actual new orders and consumer consumption.
It is also somewhat intriguing that two groups measuring the same data are getting vastly different results. While the Institute of Supply Management survey saw sharp increases in optimism, Markit’s surveys of the same manufacturing and services related data saw declines. This is one of those cases where only one can be right.
The chart below shows the composite index of the ISM surveys (simple average of manufacturing and services data).
There is a running pattern in the surveys which the initial decline mid-economic cycle reverses back up to cycle peaks. The next decline in sentiment is during the latter stage of the economic cycle prior to the onset of the ultimate recession. The recent surge in survey activity, ex-underlying strength in the actual data, suggests that sentiment is anticipating a recovery that may or may not occur.Â
The chart below shows just the ISM Manufacturing survey compared to core-durable goods orders. Core-durable goods are ex-defense and aircraft orders which is a better metric of what the average consumer is doing. The data, however, is very volatile, so I have smoothed with the monthly changes with a simple 12-month average.
Because I have smoothed the data with a 12-month average there is a slight lag to the data. However, what is clear is that there is a very high correlation between core-durable goods and manufacturing sentiment. Currently, sentiment is well ahead of actual activity which suggests that either the economy is about to come roaring back to life, which is what has been priced into the financial markets currently, or there will be disappointment.
There are a couple of important considerations with respect to your outlook with how this will ultimately be resolved. As I will discuss in just a moment, despite the ECB’s attempt to stimulate the Euro-economy the deflationary pressures are picking up steam and the majority of economies are slowing. With 40% of domestic corporate profits coming from the global community, the Eurozone is the largest consumer, it is very likely the economic drag will be felt in the U.S. soon. Secondly, the U.S. is about to enter back into a period of the year where unseasonably cold weather will resurface once again. It is currently estimated that this winter will be as cold, or colder, than last which resulted in a 2% decline in economic activity in the first quarter of this year.
