This morning the ISM Manufacturing index registered an impressive 60+ reading, indicating something that really looks like a “V” in the beaten down sector.
But the news shouldn’t make you bullish.
After all, we’re in the midst of a 15 month rally that’s been anticipating a recovery like this one. To the market, the big recovery isn’t exactly news.
And indeed, history tells us that a 60 reading on the ISM is not wildly bullish.
Below is a table highlighting the performance of the S&P 500 leading up to and following the ISM Manufacturing’s cross above 60. The average performance during the 12 months following the first cross above is 4.28% and over the two years following it is 11.92%. In most episodes over most time frames, the S&P 500 wound up higher, but gains were unimpressive considering the increasing level of economic activity. Since the earnings and economic recovery have been a cornerstone of our bullishness over the past 6 months, it is hard to justify remaining as enthused if the increased economic activity from these levels only translates into modest market gains.
As far as how the data presents, the 1987 crash is included within the table. Even if one were to view that as an outlier (although many would not), dropping the performance would only boost the 1 year forward average return to 6.1% and the 2 year to 12.23%. If you segregate the data into periods post-1970 and pre-1970, which places 6 episodes in each time frame, the post-1970 returns are notably weaker than the pre-1970 returns. We have viewed this recovery and modelled our strategy based upon the activity of the previous two worst post-war recessions, during 1973-1974 and 1981-1982. As the table below shows, those recoveries were also the ones with the highest Unemployment Rate at the time the ISM Manufacturing crossed 60 (1976 and 1983). They both also had similarly strong rallies in the year preceding the crossover. Over the past 52 weeks, the S&P 500 is up 37%. In 1976, the rally over the preceding year was 31%. In 1983, it was 52%. Those continue to be our benchmark environments and as such, the average forward returns were among the weakest. As much as we believe in the bullish catalysts we mentioned early on, we believe risk and opportunity are finally in balance. We need better valuations (lower prices or higher earnings) to compel us back into the bull camp.
Here’s the table, showing historical performance pre- and post the 60 reading. Not that one historical comparison is that useful, but we definitely seem to be closest to the scenario of 1983, when the unemployment rate at the time of the 60 cross was 9.3%, and the previous 12 months had returned 51.8%.
Following that we dipped 7.3% over the coming 12 months, though gained 17.45 over the coming 24 months.: