Diary of a Financier

PMI Lagging the Railroads: The US Fighting against a Global Slowdown

In Economics on Mon 2 Jul 2012 at 23:09

The new month opened today—as it does every month—with “Global PMI Day.” Vendors like Markit, J.P. Morgan, HSBC and RBC aggregate data from thousands of private companies in 24 countries. The results provide an appraisal of manufacturing activity known as the Purchasing Managers Index:

PMIs are based on monthly surveys of carefully selected companies. These provide an advance indication of what is really happening in the private sector economy by tracking variables such as output, new orders, stock levels, employment and prices across the manufacturing, construction, retail and service sectors.

PMI readings below “50” indicate contraction, above indicate expansion. In May, almost every reporting country’s PMI showed both a sequential decline and an overall contraction. That downward trend continued into June, according to the numbers reported this morning. Among them, the US dropped m/m from 54 to 52.5 (v. 52.9 expected), which is still an indication of expansion, albeit decelerating. The overall global actually contracted with a 48.9 reading:

Global PMI by country (June 2012)

As the passage above describes, the PMI reports cover a number of variables up & downstream. A drill-down into the specific components of PMI shows that it’s heavily biased toward Manufacturing & Services (in that order). Those are midstream variables in my eyes, and there’s absolutely no representation from upstream suppliers in the PMI surveys. Transports like railroads provide such upstream sentiment, and railroads are a more leading indicator of economic activity than PMI.

To wit, I notice the juxtaposition between these negative PMI surveys and positive rail data here in the US. The Association of American Railroads (AAR) reports Rail Traffic on a weekly basis. I always transmit the AAR report in my Top Newsstuffs, because it’s a generally unknown, untracked, comprehensive appraisal of economic conditions.

AAR’s data showed a deceleration through much of 2q12. Then, in the weeks of June 18-26, I observed:

Noticing the pickup in rail traffic lately. Railroad stocks had been strengthening too–before the FOMC’s OT2-lite announcement underwhelmed the broad market and a class action collusion suit derailed the sector. The bullish slant of railroads opposes the sequential decline in trucking activity, although both are posting gains y/y.

As I noted at that time, the rail data were “still mixed, but [are showing] continued improvement,” because up until that week, growth wasn’t even broadly negative—it had merely been decelerating on a y/y basis.

A key theme that exacerbated last year’s surge in energy prices was the disruption in the distribution mechanisms for energy supplies like oil (i.e. bottleneck in Cushing, OK). This has since been temporarily remedied, energy prices have collapsed, and the increased distribution of petroleum products has helped buoy railroads’ activity y/y.

As of last week’s AAR report, railroads have strung together some resurgent growth:

20120702-221322.jpg

More important than this granular analysis of railroads is the juxtaposition noted above: the bullish reversal in rail traffic vs. the bearish reversal in manufacturing (PMI). Given the disparate readings from each, which is right about economic growth? who will prevail?

Well, first, it’s important to realize that all of this production data isn’t as objective as it may seem. Inventories, backlogs, weather, etc. can all tamper with the amount of time it takes for real economic growth to be realized vis a vis the growth in PMI or railtraffic. The stock market should theoretically pickup on burgeoning upstream activity as a sign of increased sentiment. I think it has, with SPX having bottomed on June 1.

All else being equal, railroad data are a higher-frequency report (weekly) than PMI (monthly). The slowdown in US PMI seems to reflect the aforementioned railroad deceleration, just on a lag. That’s to be expected, given the factor of time in production’s conversion cycle. Goods take time to move downstream. Demand is elastic, and management teams manage their costs proactively.

Thus, I take this PMI data as reinforcement for that which I already knew. It’s backward-looking; it’s already happened. I knew about the slowdowns in Australia, China, and Europe. I knew the US had a rough 2nd quarter. I’m more concerned with what’s next, the future. For now, that future is bullish for a recovery trade, although I’m not certain about the duration of this bounce quite yet. More to come on that…

–Romeo (hattip Business Insider)

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  1. Great insight. Thanks

  2. […] taking the news as it comes.  The fundamentals seem to be changing still, with railroad and housing data migrating toward my thesis of a cyclical bull recovery.  Analyst have all pared […]

  3. […] has wallowed in reaction to all of this.  The globe continues to struggle with deflation, and Europe seems to lack a plan for reflation in the near future.  This all […]

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