Weak Soft Data A New Trend?

The new trend I am focusing my attention on is the deceleration of soft data. I am predicting this decline because soft data usually doesn’t surprise to the upside for long. It’s also clear that the hard data isn’t following suit which means the economy isn’t strong. The weak GDP report acts as a signal to businesses that the economy is weak and makes them pause their aggressiveness on new initiatives. Obviously, the most critical focus businesses have is how their sales are doing, but managers are always looking at the general economy to see what the future may hold. Just because some sluggish quarters in this recovery haven’t led to a recession, doesn’t mean it doesn’t have a negative self-fulfilling nature. When you play with fire long enough, you’re bound to get burnt eventually. Finally, the fiscal stimulus which was expected by small businesses hasn’t been enacted which should disappoint them. There is no exact date which I can point to where small businesses will lose hope for tax cuts, but I expect this loss of hope to gradually start showing up in the data in the next few months.

The biggest factor in determining if I continue to discuss this theme is if the soft data confirms the narrative. If not, I’ll admit I’m wrong and discuss how great the soft data remains. In my last article, I discussed some the reasons why earnings growth has accelerated in Q1. One of the bullish narratives on why earnings growth was up is because of a rebound in Chinese economic data. Just as this explanation started making the rounds, Chinese economic data has started to disappoint. The Caixin/Markit Manufacturing Purchasing Manager’s index declined to 50.3 in April which missed expectations for 51.0 and was down from 51.2 in March. This was the weakest growth since September 2016. Growth in the service sector also decelerated from 55.1 to 54.0 in April. It’s clear the Chinese economy is in a long term slowing trend as it has been for years, but the short term had perked up early this year. If that perkiness wears off, it’s bad news for firms like Caterpillar which finally had a decent report in Q1.

The ISM and Markit manufacturing reports were released on Monday. They show similar weakness to what was seen in China. The ISM Manufacturing PMI was 54.8% which was a sharp deceleration from 57.2% in March. That’s two consecutive weaker reports as the 57.7% report in February was unsustainable. Usually growth doesn’t last forever, but the reason I say it’s unsustainable is because the real data didn’t match up. The average PMI in the first three months of the year was 56.4 which is equivalent to 4.1% GDP growth. The actual GDP growth was 0.7% which is a serious divergence. The latest report is consistent with 3.6% GDP growth. That’s more reasonable, but still likely above what will be reported. The key thing to understand is whether the recent deceleration in soft data means the economy is getting weaker or if it simply means the soft data is becoming more reflective of reality as it comes back down to Earth. It seems unlikely that the hard data would perk up while the soft data weakens making them meet in the middle.

The chart below summarizes the PMI report. It’s clear in a rate of change terms that the PMI is showing weakness. It’s too early to call this a trend. I am expecting soft data weakness, but it’s a working thesis, not a fact. If the next report decelerates again, I would call it a trend. I like to look at the quotes in the report to get clarification on the metrics. A miscellaneous manufacturing firm stated "Ongoing market strength. While world/political headlines cause personal anxiety, business conditions remain solid." This is the exact opposite of what I’m seeing in the data. The consumer is very optimistic, yet growth is weak. The business may be saying that citizens aren’t hiding in a bunker because of scary geopolitical headlines and explaining how its business is strong. Perspectives vary wildly depending on how business is going. Most firms expressed confidence even though the report showed slower growth.

The Markit manufacturing PMI showed the same deceleration seen in the ISM survey. The headline PMI was 52.8 in April falling from 53.3 in March. This is the slowest growth rate since September 2016 which happens to be an exact replica of the weakness seen in the Chinese PMI report. The manufacturing recession clearly ended in 2016. The question remains if there will be a double dip.

The numbers are clearly weakening. My takeaway is that I don’t care much what these number show in terms of my opinion on the economy because they have been unreliable indicators this year. I will be looking to hard data from now until the hard and soft data coalesce. Other investors disagree with me and follow the ISM and Markit surveys very closely. That’s why I reviewed them in this article. If investors who determine stock prices are looking at a report, you must look at it too if you want to forecast where stocks will go. The stock market is near its all-time high. It shouldn’t break out and form new highs if this weakness in soft data continues. The market isn’t data dependent, but an additional headwind surely won’t help it.


The stock market is near new highs but the PMI Manufacturing reports in America and China aren’t. This wouldn’t be the first time the market ignored the data, but it probably won’t last much longer. The chart below is very disconcerting. The Citi Economic Surprise index is now negative. This is a year to date low. The surprise index focuses on the soft data since it was high earlier in the year. The longer it stays in the negatives, the greater chance this is a sustainable trend. The index fell close to -60 during the recession scare in early 2016. That’s a key marker I’ll be looking out for.

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