Global Investors: You Should Be Paying Attention To This Economic Indicator

July 12, 2015

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By Frank Holmes. Originally published at ValueWalk.

Global Investors: You Should Be Paying Attention To This Economic Indicator by Frank Holmes

Reality has set in for investors this week: Tremors are shaking up the global markets.

A “no” vote from the Greek referendum on Sunday, the vast stock market selloff in China, and the volatile movements in the price of U.S. crude oil have made it clear the worldwide economy is collectively riding the brakes. The 3.5-hour halt in trading on the NYSE Wednesday has also added to investors’ unease.

This week on BNN TV, Canada’s leading business station, I explained that an important forward-looking economic indicator we closely monitor at U.S. Global Investors can help make sense of this slowdown: the global manufacturing purchasing managers’ index (PMI), which we’ve written about many times. Coupled with this, our portfolio managers recognize that during highly volatile markets adjusting cash levels in our funds is key.

In addition to our own macro models, BCA Research , a highly respected independent research company, pointed out that PMIs in developing economies have plunged to new lows. The International Monetary Fund also revised downward its global growth forecast for 2015. On this account, bad news is good news, as central bankers are scrambling to stimulate economic growth.

As active managers, we have raised our cash levels looking for opportunities in a sloppy market, particularly in our China Region Fund (USCOX). This allows us to mitigate risk and deploy that cash when stocks look attractive per our model, which focuses on factors like high returns on invested capital, sales per share growth and dividend per share growth.

The Trend is Your Friend

It’s common for investors to look at gross domestic product (GDP) when making decisions about how to deploy capital. Unlike GDP, which looks back or in the rearview mirror, PMI is forward-looking. PMI gathers data such as global output, new orders, exports, prices and employment, making it a reliable indicator for both commodity performance and business activity. ISM, or Manufacturing Institute for Supply Management, is the U.S.-specific calculation of PMI.

Take a look at global PMI. It has continued on a three-month downtrend for the month of June.

Similarly, PMI in the U.S. peaked seven months ago but has since been modestly declining. The threat of rising rates has been a contributing factor, and although Federal Reserve Chairwoman Janet Yellen stated today that the U.S. is on track to raise rates in September, many agree that this date is too soon.

Card Counting: Using the PMI Pattern to Your Investing Advantage

Understanding PMI is one way investors can use patterns to improve their chances of positive returns in the market – just like card counting in a game of Blackjack.

When looking at PMIs, a reading of 50 or above indicates manufacturing expansion, while a reading below 50 indicates a slowing economy. PMIs for individual countries like China and Greece are negative right now, meaning that manufacturing activity is contracting.

Our investment team’s research has shown that when the one-month reading crossed below the three-month trend, there was a significant probability that materials, energy and commodities would fall six months later. Conversely, when it crossed above, manufacturing activity would ramp up, which greatly improved the performance of commodities such as copper and crude oil, along with the materials and energy sectors.

The Great Shift in Seasonal Oil

As I explain in our Managing Expectations whitepaper, using seasonal patterns, along with global PMI, is another way to understand trends in the market and the world at large.

Historically, the hurricane season in August/September has shut down the supply of oil offshore, leading to a peak in relative price around this time. But as you can see in the chart below, the new technology of fracking and a corresponding increase of U.S. onshore production, have led to a surplus, drastically shifting the shorter-term seasonal pattern in oil.

Staying Nimble During Changing Landscapes

Professor of Mathematics at the University of Oxford, Marcus du Sautoy, said it best:

“Although the world looks messy and chaotic, if you translate it into the world of numbers and shapes, patterns emerge and you start to understand why things are the way they are.”

The global markets right now indeed appear “messy and chaotic,” but curious investors and fund managers realize that specific tools and patterns help them navigate through the complexity and intensity of constantly changing landscapes.

In fact, it is the agile active management and the use of these investment tools that landed two of our funds in Investor’s Business Daily’s “Weekly Review” section today. This particular section of IBD is a screened list of top-rated stocks for the week, along with the top-performing funds that own these particular stocks. Our Holmes Macro Trends Fund (MEGAX) and Global Resources Fund (PSPFX) are recognized for owning nine of these top stocks.

Subscribing to our award-winning Investor Alert newsletter is one way investors can stay on top of geopolitical and economic events that could affect their investments. We’d really appreciate it if you’d share our publication with your friends and colleagues!

Index Summary

The major market indices were mixed this week. The Dow Jones Industrial Average rose 0.17 percent. The S&P 500 Stock Index fell 0.01 percent, while the Nasdaq Composite fell 0.23 percent. The Russell 2000 small capitalization index rose 0.30 percent this week.
The Hang Seng Composite fell 4.21 percent this week; while Taiwan fell 4.96 percent and the KOSPI fell 3.48 percent.
The 10-year Treasury bond yield rose 2 basis points to 2.40 percent.

Domestic Equity Market

Strengths

Consumer Staples, Inc. (NASDAQ:SPLS) was the best performing sector in the S&P 500 Index this week as concerns over China and Greece led investors into more defensive areas. The S&P 500 Staples Index rose 2.02 percent this week.
Utilities was the second best performing sector in this week’s risk-off environment, despite the yield on U.S. government 10-year notes rising. The S&P 500 Utilities Index rose 1.67 percent this week.

German factory orders fell more than expected. The May orders fell 0.2 percent, compared to the 2.2 percent rise in April.

Weaknesses

Materials was the worst performing sector in the S&P 500 Index this week as concerns over China slowing led to a sharp contraction in base metals prices. The S&P 500 Materials Index fell 1.64 percent this week.
Initial jobless claims in the U.S. came in much higher than expected, rising 297,000 this week.
West Texas Intermediate (WTI) crude oil saw the biggest down week in a while as concerns over global growth and crude supply intensify. WTI fell 7.25 percent this week.

Opportunities

The preliminary reading of the University of Michigan’s consumer sentiment index for the month of July will be released next week. Analysts are expecting a rise, which would be positive for consumer-oriented plays.
Industrial production in the U.S. is expected to rise to 0.2 percent for the month of June. A positive reading would benefit more cyclical industries.
After previous negative readings, the U.S. Empire state manufacturing index is expected to turn positive for the month of July.

Threats

Consumer prices are expected to have climbed only 0.3 percent for the month of June, down from 0.4 percent the prior month.
Germany’s ZEW Survey of Expectations and ZEW Current Situation Survey are both expected to decline for the month of July.
Markets are becoming increasingly concerned that the Chinese economy is running out of steam. A weaker China would not only negatively affect global growth, but growth in the U.S. economy as well.

The Economy and Bond Market

Global markets recovered Friday, ending a turbulent week, as worries about Greece’s debt crisis and China’s equity meltdown eased. Belying the daily volatility, U.S. benchmarks were little changed. Yields on “safe-haven” 10-year U.S. Treasury notes and German bunds rose Friday. The euro also gained on growing optimism that Greece and its creditors would be able to agree to terms that would save the country from default.

Strengths

The ISM non-manufacturing index inched up to 56.0 in June from 55.7 in May, suggesting some acceleration in services activity during the month. This was modestly below expectations of 56.4 and is consistent with continued moderate growth.
The JOLTS, or Job Openings and Labor Turnover Survey, report showed a further increase in job openings to 5.36 million in May from 5.33 million in April (revised from 5.37 million initially). This was above the expected 5.300 million and left the rate of job openings unchanged at 3.6 percent. Most job openings added over the past 12 months have been in retail trade, professional and business services, and health care and social assistance.
Initial jobless claims rose 15,000 to 297,000 for the week ended July 4. Despite a modest increase, this marked the 18th straight week below 300,000.