Below 50 Markit PMI!

It was wrong in to predict that the Markit manufacturing PMI would beat estimates. This February flash reading had an across the board miss. It was correct that outside of the Boeing 737 Max delays and the coronavirus the manufacturing sector is doing well. The latter had a significant impact on the Markit report. 

This was from the first half of February which arguably will be when the coronavirus has the biggest impact. In the 2nd half of February, we’ve seen the number of cases increase at a slower rate which is why it might increase a bit in the final February release.

Markit Composite PMI fell from 53.3 to 49.6 which is a 76 month low. This was the first contraction in U.S. business activity since the financial crisis outside of the 2013 government shutdown. It reinforces the belief that Q1 GDP growth will be weak. 

In the comment section of this report, Markit stated the survey data is consistent with just 0.6% GDP growth in February after being above 2% in January. If manufacturing takes a temporary hit, the odds of below 2% GDP growth will increase. Growth will likely in below 1.5%, but the stock market will likely ignore this. Weakness is transient.

Specifically, the flash manufacturing PMI fell from 51.9 to 50.8 which was a 6 month low. It’s surprising that the services PMI took the brunt of the impact from the coronavirus since manufacturing is more international. Manufacturing output index fell from 52.4 to 50.6 which was a 7 month low. 

As you can see from the chart below, the services PMI cratered as there was a massive downside surprise. Expectations make sense since you wouldn’t think the service sector would be hurt by an international event. Specifically, the services business activity index fell from 53.4 to 49.4 which was a 76 month low just like the composite had.

Composite new orders fell for the first time since data started being collected in October 2009. This expansion has been so long that data sets which have been collected for over 10 years don’t include a recession for us to compare weakness to. There were supplier delays because of the coronavirus. 

Employment growth was the slowest in 4 months. That’s way different from the strength shown in the low jobless claims reports. The good news is business confidence hit an 8 month high. That tells you this weakness is transitory.

Do We Trust The Markit Report?

Now let’s look at the results from each sector. The service sector had its first decline in business activity in 4 years. The rate of decline in new business activity was the highest since October 2009 just like the composite index. It’s notable that the decline was moderate still. Because of the coronavirus, new export orders fell as clients were hesitant. 

Obviously, pressure on capacity fell since demand was lower. Employment growth slowed and business confidence was the highest since June. Input prices were up the least in 5 months. Unlike what the regional Fed reports showed, the prices received index only increased fractionally.

Manufacturing was a source of strength in this report which sounds odd because it fell. 7 month low in output was caused by weak demand and delays in deliveries because of the outbreak of the coronavirus in China. 

Output expectations hit a 10 month high because, outside of transitory factors, the manufacturing sector is doing really well. Inflation was low as cost growth fell and prices were raised fractionally. That makes sense because the CRB commodity ETF is down 6.12% year to date.

As we analyze the importance of the Markit report, recognize that I was incorrect in previous articles when I stated the ISM reports don’t include results from small businesses (they do). It’s clear that any index that is impacted by transitory factors will be weak. But even in the Markit report, there were clear signs that the economy would be in great shape if it wasn’t for the coronavirus. Markit services PMI has almost always been below the ISM services PMI.  Meaning, the ISM PMI composite might not crater. We will find out early in March.

Economic Growth Update

This Friday’s update from ECRI was interesting because it includes data from the monthly coincident index. This index was up 0.1 to 187.5, but the yearly growth rate fell from 1.7% to 1.5% which is very close to the 2016 trough. I wrongly expected the December reading to be the trough. Because of the impact of the coronavirus, growth might fall further in February. 

ECRI leading index fell 0.4 to 147.7 which pushed its yearly growth rate down 1% to 3.8%. That’s a 2% decline in 2 weeks as you can see from the chart below. It’s still optimistic on the 2nd half of 2020.

On Wednesday, the Atlanta Fed’s Q1 GDP growth Nowcast rose from 2.4% to 2.6%. PPI and residential construction reports caused it to raise its estimate of real gross private domestic investment growth from 5.1% to 6.4%. NY Fed Nowcast spiked sharply as it went from 1.39% to 2.01%. It was helped the most by permits; every new report was positive. Both of these estimates are too optimistic. Finally, the usually optimistic St. Louis Fed Nowcast only sees 1.93% GDP growth which is surprisingly more in line with reality.

Conclusion

Markit PMI was very weak. While its estimate of service sector activity is too bearish, many are more bearish on Q1 GDP growth than the average of the regional Fed Nowcasts which is 2.18%. And, I see growth coming in near 1.5%. ISM services PMI will likely be more optimistic than the Markit report. And overall activity will improve in Q2 when the transitory issues are behind us.