- Recently there have been concerns that the US economy’s reopening boom is cooling off.
- Not that the economy is declining, but rather that we’ve hit “peak data” – or that growth is flattening out some.
- But this is not the case, and there is plenty of reasons to believe that the economy can keep accelerating from here.
- This is an opinion column. The thoughts expressed are those of the author.
- See more stories on Insider’s business page.
There’s always a reason things are about to get worse.
Throughout the pandemic, pessimistic forecasters have doubted the pace of the US economy’s recovery. And now that the consensus has largely caught on to the US economic boom, there’s a new story for the worrywarts: “peak-data.”
The idea with “peak data” is that the pace of economic growth cannot possibly get any stronger and that growth will continue at the current pace instead of accelerating. With economic growth leveled off, so too will equity markets level off or potentially come under some pressure, so the thinking goes. Sorry, but I disagree.
There are two ways to think about economic data: momentum and the level of activity. Momentum refers to how economic conditions are changing compared to the recent past – are things picking up or slowing down? Where are things going? The level of activity measures how far conditions are from their historical averages – is the economic data right at this moment better or worse than average? How are we doing right now?
Some measures are designed to measure momentum, while others are designed to look at the level. For example, the ISM manufacturing PMI measures momentum, asking factory purchasing managers about growth relative to the previous month. By contrast, the unemployment rate would be an indicator used to measure the level of economic activity.
It should go without saying that since the market is generally concerned with future profits, the strongest period for market returns is early in the business cycle immediately following the slump in the economy. This is the period when the momentum in the economic data is strong and the level of activity is still low.
The worst period for the markets is when the opposite is true – the economy is at a high level (i.e. low unemployment) and the momentum begins to turn south. That usually signals the economy is at its peak and may slump towards f a recession. What happens in between is largely random, where investors can expect average returns. Do people stop investing the first year after a recession?
Let’s look at the ISM manufacturing PMI specifically. The survey asks about 300 purchasing managers whether activity is up, down, or the same relative to the prior month. A level above 50 is consistent with factory expansion, while a level below 50 signals a contraction. But ISM tends to send more false signals than correct ones, dipping below 50 despite a still-expanding economy or vice versa.
For example, during economic booms in the 1990s and 2010s, the ISM had several dips below 50 that lasted longer than three months. In the miserable economy of the mid-70s, the ISM manufacturing PMI stayed above 50 well into recession. For those overachievers, I go into a more detailed discussion on the ISM here.
Lately, the “peak data” chatter is conjuring up memories of 2010, when fears over the outlook swelled soon after the recession ended despite the economy having plenty of room to grow. But as with all historical comparisons, it is important to note that there are many distinctions between now and then.
The most obvious starts with the ISM manufacturing PMI itself. One reason why the ISM is as strong as it is, is because supplier delivery times are quite long. As has been widely reported, the pandemic has upended manufacturing supply chains (workers off the job, consumer preferences unexpectedly changing) and as a result, it takes longer amounts of time to move the product out the door. Eventually, as the economy normalizes and workers return to factories, supply chains will normalize and delivery times will decline. Of course, if delivery times end up declining, it is likely the result of a pick up in production and a rebuilding of inventories. That’s not necessarily a bad thing and it’s not exactly clear why increased production is bad for stocks.
Second, the consensus now versus then is quite different. A persistent feature during the period following the financial crisis was that the consensus was too optimistic on growth. For years, the consensus took a “wait till next year” approach to the economy. Growth may have been weak but the consensus always seemed to believe 3% GDP growth was just around the corner. This period feels different.
Indeed, during the pandemic, the consensus overestimated the size of the GDP drop and has continued to underestimate the speed of the ensuing recovery. Moreover, despite what’s likely to be a strong year of growth, the consensus expects meaningful slowing as growth cools from 6.6% in 2021 to just 3% in 2022 (Q4/Q4).
Next, there is a global dimension that cannot be ignored. In 2010, peak US economic data was not the precipitating factor behind that year’s stock market sell-off. Indeed, US equities kept rallying weeks after the ISM was thought to have “peaked.” It was the sovereign debt crisis in Europe that started the sell-off in stocks. As our nearby figure shows, the pressure on US equities built as credit spreads in Europe’s periphery widened. The causality behind the story is all wrong. It was not about peak data, but bad news out of Europe likely tightened global financial conditions, weighing on US activity.
Of course, this has important implications for today because the risks to the global economy skew the other way as the rest of the world reopens. Following the US, we will likely see Europe reopening. Following Europe, emerging market economies in Asia and Latin America should reopen. Each area of the world that opens after the US is also a region of the world with more open economies (trade) than the US.
For investors, “peak ISM” may have important investment implications just not in the way some imagine. It’s not about going short US equities, or expecting some deep stock market drawdown because the data is no longer accelerating. Instead, investors are encouraged to use sell-offs in US stocks as opportunities to add to positions overseas. As the rest of the world recovers, it will provide a tailwind to US factories, but should also imply a weaker US dollar and US equity underperformance relative to the rest of the world.