Flash PMI Disappointment

Markit released its euro area composite Flash PMI and the Flash PMIs for the “core” countries Germany and France on Tuesday. The data once again showed that economic growth in Europe is not much to write home about. Germany’s data look superficially good, but there is a widening gulf between manufacturing and service sector data, with the former weakening markedly.

The euro area composite output index fell to a 9 month low, the manufacturing PMI to a 14 month low – at 50.5 it remains barely in positive territory. Note in this context that in spite of the popular myth that manufacturing is only an insignificant part of the economy, it is actually its largest and most important part. In GDP accounting, almost the entire production structure is ignored (only investment in fixed capital assets is considered). And yet, if one looks at industry gross output tables, it becomes clear that this ignored portion of the economy actually represents the bulk of economic activity. Properly considered, consumer spending amounts only to about 35%-40% of economic activity, not 70% as is generally assumed. In short, manufacturing PMI data are actually a rather important gauge of an economy’s health.

France’s PMIs remain in contraction, even if it is mild at this point. However, it is not surprising that French unemployment remains near multi-year highs and that the government consistently fails to meet its budget deficit targets.

Euro area, Markit composite PMI and GDP growth – click to enlarge.

 A few salient quotes from Markit’s Flash PMI reports (the detailed reports can be viewed, resp. downloaded here):

Euro area overall:

“Euro area business activity grew in September at the lowest rate seen so far this year, according to the preliminary ‘flash’ PMI survey data.

At 52.3, down from 52.5 in August, the Markit Eurozone PMI™ Composite Output Index fell for a second month running, dropping to its lowest since December of last year. At 52.9, the average quarterly reading for the three months to September was also the lowest so far this year.

By sector, growth of services activity slowed to a three-month low, while new business growth was the weakest since March. Employment in services barely rose as a result and prices charged fell slightly on average. Future expectations also nudged lower to the least optimistic since July of last year.

Manufacturing fared worse than the service sector with the headline PMI falling to 50.5, its lowest since July of last year and edging closer to the 50.0 mark that signals stagnation. Although factory output grew slightly, new orders fell for the first time since June of last year.”

Germany:

“September data signaled a continuation of the ongoing expansion in German private sector output, as highlighted by the seasonally adjusted Markit Flash Germany Composite Output Index rising slightly from 53.7 in August to 54.0. The current period of growth now stretches to 17 months and surveyed companies generally linked this to increased order intakes.

However, the gap between manufacturing and services widened further in September. Production growth in the goods-producing sector slowed to a 15-month low, while service sector output rose at a slightly faster pace compared to August.

As has been the case since July 2013, the volume of incoming new business placed with German private sector companies rose during September, but the rate of increase eased for the fourth month running and was the weakest in one year. Slower growth was largely attributed to the manufacturing sector, where new orders contracted for the first time since June last year amid reports of a weakening economic environment.”

France:

The latest flash PMI data indicated a fifth consecutive monthly decline in French private sector output during September. At 49.1, down from 49.5 in August, the seasonally adjusted Markit Flash France Composite Output Index, based on around 85% of normal monthly survey replies, was at its lowest level in three months, albeit signaling a marginal rate of contraction.

Service sector activity fell for the first time in three months during September, offsetting a slower decline in manufacturing output.

Underlying reduced activity was a drop in the level of new business received by French private sector firms during the latest survey period. Although slight, the reduction in new orders reversed a rise in August. Whereas manufacturers signaled a solid decline in new work, service providers registered a fractional fall.”

(emphasis added)

French, German and rest of euro area PMI output indexes – click to enlarge.

Although no-one should have been surprised by this, surprise was allegedly registered by market participants.

Stock Markets Plummet

The action in major European stock markets looks more and more like a beginning decline after a failed rally that “back-kissed” a previously broken major trend line. The probability that this interpretation is correct is enhanced by the fact that the European indexes have diverged from the S&P 500 twice in a row recently (i.e., two new highs in the SPX were not confirmed by the European indexes. Note that these indexes have fared far worse in dollar than in euro terms to boot).

Below is an updated version our previously posted comparison chart with adapted annotations. The chart shows the “core country indexes” DAX and CAC-40 compared to the SPX. Admittedly, the most recent decline is still young, but this is definitely technically suspicious action and therefore deserves to be highlighted.

The action in European stocks suggests that the recent rally has cemented the previously registered divergence with the SPX and represents a rebound that may have failed right at the trend line that has provided support during the preceding uptrend – click to enlarge.

An additional remark to this: China’s manufacturing PMI data came in slightly “better than expected” on Tuesday morning, even if they were not particularly strong either. Many had feared the data would indicate contraction, but a small expansionary reading was in fact eked out – which was enough to give the Shanghai stock market a small boost.

In light of this it is actually noteworthy that European markets reacted so negatively to the so-so European Flash PMI data. After all, there is still an expansion underway Europe-wide, even if its pace is clearly weakening. Since this was probably no secret even before the data release, we conclude that market participants were simply looking for an excuse to sell.

Conclusion:

After several years of heavy bombardment with ultra-easy monetary policies, only the US has so far managed to exhibit a consistent improvement in economic data. However, US data are just as suspect, on the grounds that they reflect the effects of a huge expansion in the US money supply (exceeding the money supply growth achieved by the ECB, let alone the BoJ, by far). Thus the greater growth rate in aggregate US economic activity contains an unmeasurable, but likely quite large, malinvestment component. When considering European data one must keep in mind that credit expansion has gone into reverse in several peripheral countries and a lot of malinvested capital has been liquidated. Alas and alack, the ECB appears intent on reigniting boom conditions, even though it has so far not succeeded.

As regards stock markets: while US stocks have done significantly better than European ones lately, even the major US indexes are hovering just above trend line support after just two days of selling (as a result of the wedge-shaped advance of recent months, the support trend line has crept very close to current prices). Meanwhile, US small cap stocks are very weak, and so are market internals. Thus the strong showing in cap-weighted indexes has masked a lot of weakness spreading under the surface. Caveat emptor – risk remains very high.