Global equity markets have been hemorrhaging from the debt crisis in the European Union that began in Greece and subsequently spread to Portugal and Spain’s equity markets, losing more than 15% in terms of US dollars since the recent high in mid-April.
Source: I-Net Bridge.
With long-term trend-lines broken …
Source: I-Net Bridge.
… what are the equity markets telling us?
Stock markets are in a big way driven by underlying economic fundamental factors. Perhaps the single most important indicator of underlying global economic growth is the Global GDP-weighted Manufacturing Purchasing Managers Index (PMI). The GDP-weighted PMI for each major economic region (Japan, U.S., U.K., Eurozone and China) is weighted according to the sizes of their economies. A reading in excess of 50 indicates expansion of the global economy while a reading below 50 indicates contraction. The GDP-weighted PMI leads global (OECD) economic growth by approximately one quarter.
Sources: I-Net Bridge, Plexus Asset Management.
Approximately 80% of the 12-month momentum of the MSCI World Index since 2003 can be explained by the Global GDP-weighted Manufacturing PMI. From the graph below it is evident that the global equity market ran significantly ahead of the underlying global economy.
Sources: I-Net Bridge, Plexus Asset Management.
Are stock markets expecting an implosion of the Global GDP-weighted PMI similar to that of 2008?
The situation in 2008 was a global liquidity problem where the trust between banks worldwide went for a loop, resulting in interbank lending rates sky-rocketing. The TED spread – three-month dollar Libor less three-month Treasury Bills – climbed to nearly 500 basis points as lenders perceived an increasing risk of default on interbank loans. Global trade effectively came to a standstill that saw Purchasing Managers indices plummeting.
Although the TED spread has widened somewhat in the past few weeks it remains within the range that persisted from 2002 to end 2006. It is therefore evident that the current debt crisis is not a global liquidity crisis.
Sources: I-Net Bridge, Plexus Asset Management.
While it can be expected that the Global Manufacturing PMI will be negatively impacted by the debt crisis and fiscal austerity in the European Union, it should be seen in context. The situation in the European Union is a debt problem in the so-called PIIGS countries (Portugal, Italy, Ireland, Greece and Spain) that collectively amounts to approximately 35% of the EU’s GDP or 7.6% of Global GDP. Two thirds of total EU trade is intra-EU, while the EU accounts for approximately 40% of global imports.
Despite the crisis the preliminary Eurozone Services PMI in May improved to 56.0 against 55.6 in April, while the manufacturing PMI fell from 57.6 to 55.9 but was still expanding. While domestic demand in the Eurozone may be faltering, the manufacturing PMIs for export orders have risen as the euro weakness has started to boost exports of major countries in the Eurozone such as Germany. With the Eurozone GDP-weighted PMI (manufacturing and services) leading the economy by approximately three months indications are that the region’s economy in the second quarter may be growing at a pace in excess of 2% compared to a year ago.
Sources: I-Net Bridge, Plexus Asset Management.
However, given the leads and lags of the austerity measures introduced in the affected countries the jury is still out on what the Eurozone PMIs will be in the coming months.
The Baltic Dry Index, which measures shipping rates and is an excellent indicator of global trade, has turned the corner for the better in March and is still rising despite significant increases in capacity.
Sources: I-Net Bridge, Plexus Asset Management.
Apart from the European routes Shanghai Containerized Freight indices have all picked up, with the North American routes being exceptionally strong, echoing the strong pick-up in the Baltic Dry (Bulk) Index. However, shipments to Europe have started to increase, while the North American routes have experienced a continued rise in transport demand for the past four months, resulting in idle ships being recommissioned.
Sources: Chineseshipping.com.cn, I-Net Bridge, Plexus Asset Management.
The increase in freight rates and the continued rise in export volumes to especially the U.S. are good news for the Chinese economy.
Sources: I-Net Bridge, Plexus Asset Management.
The worsening debt crisis in the Eurozone together with the sharp depreciation of the euro against the yuan will have a negative impact on China’s economy. The impact will be muted, though, as only 16% of China’s exports is destined for the Eurozone. In the light of what is happening on the shipping front and the limited overall impact of the Eurozone on China’s exports, China’s manufacturing and non-manufacturing PMIs are likely to hold up in the short term. Furthermore, the Chinese government’s recent decision to defer the exit strategy of its fiscal stimulus package has erased major concerns regarding the economy, especially in the short term. However, GDP growth on a year-ago basis is likely to moderate to approximately 11% in the second quarter of this year.
Sources: Li & Fung, Plexus Asset Management.
It can be expected that the improved export tariffs and increased volumes will underscore both the U.S. PMI manufacturing and non-manufacturing indices in the short term.
Sources: Li & Fung, ISM, Plexus Asset Management.
But the weakness of the euro together with lower demand as a result of the austerity measures is likely to hurt U.S. exports to the Eurozone as the latter accounts for 20% of the U.S. export market. Over the past two years, however, a significant correlation has developed between China’s manufacturing PMI for imports and that of the U.S.’s GDP-weighted PMI for exports (manufacturing and non-manufacturing). With China’s economy expected to remain buoyant the U.S. GDP-weighted PMI for exports is likely to hold up above 50 – indicating expansion – despite possible falling exports to the Eurozone.
Sources: Li & Fung, ISM, Plexus Asset Management.
Although circumstances and factors may change rapidly, a train smash similar to 2008/2009 in the GDP-weighted manufacturing PMI is unlikely. A decline towards the 50 level is possible but it will continue to indicate expansion of the global manufacturing sector, albeit at a slower rate. It therefore appears that the significant hammering of global stocks was a correction from an extremely overbought market (as in 2004). I will not be surprised if the 200-day and 40-week moving averages will soon be tested and broken on the upside (as in 2004). As always, I will be monitoring these developments with a beady eye.
