PMI & Equity Factor Performance

How Sensitive Are Equity Factors to Changes in the PMI?

July 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Value and Size have a positive relationship with the PMI, similar to the S&P 500
  • Indicates that risk sentiment is a core driver of factor performance
  • Investors can consider incorporating variables like the PMI in a risk management framework

INTRODUCTION

A physicist, a chemist, and an economist are stranded on an island, with nothing to eat. A can of soup washes ashore. The physicist says, “Let’s smash the can open with a rock”. The chemist says, “Let’s build a fire and heat the can first”. The economist says, “Let’s assume that we have a can-opener…”.

Despite economists being regularly featured as the butt of jokes as well as in less-humorous research that shows that their economic predictions have low predictive value, they are ubiquitous in the financial world. There is no escaping them when watching Bloomberg, CNBC, or other channels dedicated to financial markets.

Given the poor track record of economists, some investors prefer to avoid forecasts altogether and follow a data-driven approach. However, most economic data like GDP growth or the unemployment rate is either lagging or coincident in nature, which typically means it is already reflected in the market and therefore less useful (read Factors & Interest Rates).

Leading indicators might be more interesting as they, well, supposedly lead. One of the most commonly watched indicators is the Purchasing Manager’s Index (PMI), which describes the views on business conditions of purchasing managers from 400 companies of 19 primary industries. Purchasing managers are akin to capital allocators as they have to make investment decisions on how to allocate resources.

In this short research, we will investigate if there is a relationship between the PMI and the returns of common equity factors like Value or Momentum and if affirmative, can be used for allocation decisions.

70 YEARS OF PMI DATA

The Institute of Supply Management (ISM) began reporting the PMI in the US in 1948, which provides long-term data for analysis. A PMI reading of above 50 implies that business