[Originally published on SeekingAlpha]
Many market participants are focused on the Fed meeting this week, but we like to focus on hard data rather than the nuanced language of the Fed statement. We find it important to consider the economic data that could affect U.S. stocks and therefore ETFs like the SPDR S&P 500 Trust ETF (SPY) and the iShares Core S&P 500 ETF (IVV), which are some of our investment vehicles of choice.
In this article, we are going to focus on two economic indicators that typically align with U.S. recessions, both of which have gone into contraction recently. This is not positive news for SPY and IVV. Our two indicators are the ISM Manufacturing index (or PMI) and Industrial Production. When PMI drops below 50, that signals contraction in manufacturing based on the ISM survey data.
Industrial Production (we will call this IP going forward for simplicity) turning negative on a year-to-year basis also points to economic contraction. It is fairly amazing to us that the jobs number each month is so very important to market participants when employment is a lagging indicator. PMI is generally considered to be a leading economic indicator and IP is a coincident indicator. These seem much more useful in determining the state of the economy than a lagging indicator like employment.
We have obtained the data for these two economic indicators from the Federal Reserve database and plotted them with a few tweaks to better illustrate how they correspond to economic growth. First, the PMI number we plot is the difference between the published PMI number and 50, which is the threshold for economic growth or contraction as described here. Second, the Industrial Production index is a seasonally-adjusted index that can be noisy on a month-to-month basis and also has potential noise from the seasonal adjustments. For these reasons, we look at the year-to-year change rather than the raw index or the monthly change.
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