US Manufacturing Forecast Declines

Weekly Note
Written By Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

Lower PMI Levels Forecasted During 4Q22

ISM Manufacturing Index Forecast vs Historical

The projected Manufacturing PMI decline supports a cautious, risk-off approach to financial markets during 4Q22 and 1Q23. Our research provider, MarketDesk, projects PMIs will approach 50 during the next three months before dipping below 50 (i.e., manufacturing contraction) during 1Q23. A downward trending PMI doesn't necessarily indicate the market will trade off aggressively, but it points to an unattractive risk/reward setup with below-average and potentially negative returns.

What is PMI?

The ISM Manufacturing Purchasing Manager Index (PMI) is a monthly indicator of U.S. economic activity based on a survey of purchasing managers at more than 300 manufacturing firms. It indicates the level of demand for products by measuring the amount of ordering activity at the nation's factories. The updated PMI number is announced on the first business day of each month. A PMI above (below) 50 indicates an expansion (contraction) of the manufacturing segment of the economy compared to the previous month. A reading of 50 means no change.

ISM Manufacturing PMI vs Rolling 12-Month S&P 500 Price Return

ISM Manufacturing PMI vs Rolling 12-Month S&P 500 Price Return

Why Are PMI Levels Important

The chart above compares the ISM Manufacturing PMI vs the S&P 500 rolling 12-month price return. It shows that the S&P 500's returns moved in line with the ISM Manufacturing PMI over the past two decades. A rising PMI indicates the manufacturing segment of the economy is expanding, which historically points to positive forward equity returns. In contrast, a falling PMI indicates the manufacturing segment of the economy is contracting.

The relationship has steadily strengthened as more investors incorporate PMI readings into their asset allocation decisions. Since 1990, there has been a 0.77 correlation between the ISM Manufacturing PMI and S&P 500 price returns.

Actionable Advice

We remain optimistic about the US stock market based on the medium-term technical trends we follow. The trends show the US stock market is in better shape than it was at the start of the summer.

Given the current recession, we favor a value sector weight approach vs. a growth stance. Historically, stocks paying dividends and having a reasonable price-earnings ratio have performed better in a recessionary environment.

We are watching two dominant themes, inflation and Fed policy, which are in the driver's seat for this market. Inflation remains the most critical data point to watch, and this week's data highlights inflation's persistence.

Therefore, investors need to review their holdings, put a defensive plan in place, and consider tax-harvesting positions in their portfolios that are technically weak. This advice would especially be true of portfolio holdings that have continued to show technical weakness this summer, including an uptrend for the market.

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Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

I am currently the Managing Partner for our independent investment advisory firm, Optima Capital Management. Together with my business partners, Todd Bendell CFP® and Clinton Steinhoff, we founded Optima Capital in 2019 as a forward-thinking wealth management firm that serves as an investment fiduciary and family office for high-net-worth individuals and families. In addition to being the Chief Compliance Officer, my role at Optima Capital is portfolio management. I have over 18 years of experience in managing investment strategies and portfolios. I specialize in using fundamental and technical analysis to build custom portfolios that utilize individual equities, bonds, and exchange-traded funds (ETFs). I began my financial services career with Merrill Lynch in 2003. At Merrill, I served in the leadership roles of Market Sales Manager and Senior Resident Director for the Scottsdale West Valley Market in Arizona. On Wall Street Magazine recognized me as one of the Top 100 Branch Managers in 2017. I am originally from Saginaw, Michigan, and a marketing graduate from the W.P. Carey School of Business at Arizona State University. I am a Certified Private Wealth Advisor® professional. The CPWA® certification program is an advanced credential created specifically for wealth managers who work with high net worth clients, focusing on the life cycle of wealth: accumulation, preservation, and distribution. In addition, I hold the following designations - Chartered Retirement Planning Counselor (CRPC®), Certified Divorce Financial Analyst (CDFA®), Certified Plan Fiduciary Advisor (CPFA), and Retirement Management Advisor (RMA®). In the community, I am a member of the Central Arizona Estate Planning Council (CAEPC) and serve as an alumni advisor and mentor to student organizations at Arizona State University. My interests include traveling, outdoors, fitness, leadership, entrepreneurship, minimalism, and computer science.

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