ISM Manufacturing Report Signals 4.9% GDP Growth

In previous articles, we’ve discussed how emerging markets are outperforming America after several years of underperformance. Emerging markets usually have a lower PE multiple than America and developed markets because their capital markets aren’t as trusted and their political systems are more uncertain. Lately, there has been a silly narrative that because President Trump appears seemingly volatile and Congress isn’t getting much legislation passed that the American political system is uncertain. If not getting new laws passed is the biggest worries, it’s not a big deal. The lack of political risk means America’s risk of becoming the next Venezuela is lower than emerging markets like Brazil which has seen many leaders go down because of corruption scandals recently. America and other developed markets may be prone to populism, but it’s nothing like the emerging markets.

As you can see from the chart below, the average spread between developed and emerging market multiples is 2.7 points. It’s now at 3.7 points which means despite the rally this year, emerging markets might have more room to run. Much of this is driven by China which is finally seeing GDP growth stabilization. If China has a great 2018, this gap will be closed. If the global economy continues to grow, commodity prices will accelerate which should have a net positive effect on emerging markets which are commodity exporters.

Economic News

The August manufacturing ISM PMI was an amazing report as it came in at 58.8. That beat the consensus estimate of 56.6. The high end of the consensus was 57.5, which it beat. This was the highest headline PMI report in the past 12 months. A report of 58.8 is equivalent to 4.9% GDP growth. Clearly, there’s no chance in the world the GDP report comes in at 4.9% for Q3. However, the point is to show the manufacturing economy is doing well. The chart below breaks down the subsets of the report. As you can see, most of the reports are showing faster growth. This great report might have been one of the reasons why the stock market rose despite the weak labor market report.

Within the ISM reports there are statements companies make to describe how business is doing. A computer and electronics products firm said "Overall very steady; starting to pick up as expected." This means the back to school season was strong for the PC manufacturers.

The second biggest report on Friday besides the BLS labor report was the auto sales data. As you can see from the chart below, the trend is heading in the wrong direction. The auto sales in August were 16.14 million which was down about 2% from last year. Ford sales were up 2.1% and GM sales were up 7.5%. Fiat Chrysler’s American sales were down 11%. Ford said they saw a sales bounce back after hurricane Katrina meaning there might be a boost from hurricane Harvey. It’s amazing to see how Tesla is never on any of the lists of the top car companies because it never comes close to these firms in sales despite it having a larger market cap than Ford and GM. The excuse that it doesn’t have a mass market priced car won’t exist in 2018 as the Model 3 is being sold. The stock promoters trying to claim it is a technology firm are deflecting from the lack of comparable sales and profits.

Besides the weak car sales, another data point the bears highlighted was the construction spending report which showed a 0.6% decline on a month over month basis and a 1.8% increase on a year over year basis. Keep in mind, this is for July as much of the other housing data is. This is similar to auto sales in that the demand will improve when the hurricane rebuild starts sometime in the next few weeks.

GDP Recap

There was an unusual change in the latest GDP forecasts in that the NY Fed’s estimate increased and the Atlanta Fed’s estimate fell. Clearly, they don’t look at the data in the same way, which is why they have different predictions. That’s why it’s possible for them to move in opposite directions. The other reason is they come out at different times. As you can see from the chart below, the GDP forecast from the NY Fed is at the highest point it has ever reached. This is while the Atlanta Fed’s forecast has fallen to the lowest point since the prediction started being made in early August. That’s because the NY Fed started too low and the Atlanta Fed started way too high like it usually does.

As you can see, the ISM employment index and the ISM manufacturing report were the principal drivers behind the .24% increase in expectations. Next week the Q4 estimate will come out. I doubt it will be able to correctly factor in how the hurricane will impact the results because there will be sharp changes in the data starting in a few weeks.

The GDP Now Atlanta Fed forecast fell from 3.3% to 3.2% because of weakness from declines in the forecasted growth rates of real government spending and real nonresidential structures. A decline in government produced GDP is the best source of a decline as the private sector should drive growth during economic expansions. The blue-chip GDP forecast is at 2.7% which is right in the middle of the two forecasts. Finally, the St. Louis Fed is forecasting GDP growth at an annualized quarter over quarter growth rate of 3.66% making it the most optimistic of all the forecasts. I think any report that shows growth more than 3% would be fantastic.

Conclusion

With the big positive revision to Q2 GDP growth taking it up to 3.0% and the slight decline in some Q3 estimates, the odds of an acceleration in growth have diminished. This doesn’t mean stocks are in a bad spot. Any growth rate between 2% and 3% is a Goldilocks scenario that is great for stocks. Anything below 1.5% signals we need to worry about a recession and any growth rate above 3.5% means the Fed will be hiking rates.