The graph below attempts to contrast the erosion in the global PMI indexes against the rising optimism of stock analysts. Six series of data are plotted: the changes in earnings expected for the companies in the S&P 500 and the Euro Stoxx Index, and four PMI indexes for the US, the Euro area, Germany, and China. Each of the series is indexed to 100 in April, the month where most of the PMI data peaked.
The chart shows the growing divergence between expectations for earnings and the global PMI indexes. These indexes will be important to watch over the next couple of months. As John Hussman noted in Recession Warning , three of the four metrics that provided a warning of an approaching recession in 2007 are in place. A drop in the PMI index to 54 or below is the remaining indicator in that original set of metrics that hasn't signaled. But the weakness in the growth rate of ECRI's Weekly Leading Index ā which leads the PMI by about three months ā when combined with the other indicators are currently enough to expect a period of renewed weakness.
Therefore there are two dynamics that are now in place that were also in place near the end of 2007. Global earnings expectations are climbing while global PMI indexes are declining and there is sufficient evidence in hand to be concerned about a period of renewed weakness in the U.S. economy. The graph below shows the period between 2007 and 2008 using the same indices (leaving out China in this case because its economy peaked in 2008). It shows the same divergence in earnings expectations and PMI indexes along with when the recession signal was given in 2007.
The spread between the changes in global PMI Indexes and global earnings expectations is an increasing concern, especially considering the evidence that increases the probability of renewed economic weakness. Earnings growth forecasts have never been higher measured by the median expectation. This alone, typically leads to poor stock performance. The growing gap between PMI Indexes and earnings expectations increases these potential risks.
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