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Weekly eLetter 12/6/2019 – Building the Worry Wall

As if to prove that journalism is an art and not science, we too often see that an ounce of bad news carries the same weight as a pound of good news. We’re not sure as to why that is but we suspect it’s that news writers and reporters think scary stuff is more interesting and more powerful than warm and fuzzy stuff. Admittedly some portion of this phenomenon – where people actually DO react more extremely to negativity — is rather prevalent in the investment community.

We actually do know, empirically, that the markets tend to react more dynamically to negative news than good news. That’s a fact that we have to live with (and respond accordingly). But what really gets our goat is when editors and writers are given both good and bad news on the same issue, decisions are made and the good never sees the light of day. This week, we were down by at least one goat. Let me tell you how that happened.

Each month a couple of major surveys are done that track and report on the manufacturing segment of the economy. Both surveys are done by large and well-respected firms. The surveys usually come out about the same time of the month and as it happens this month they were released on the same day. One survey is produced by the Institute of Supply Management while the other is done by IHS Markit. Both are referred to as ‘Purchasing Managers Index’ or simply ‘PMI’. When relying on information that has been produced by a survey it’s a very good idea to consider if there may be sampling errors, bias in the questionnaire or other problems that may affect reliability. That’s why we say ‘Never trust a number until you see it twice’.

This week, the ISM top-line number was 48.1. That’s disappointing since any number below 50 is an indication of contraction in the manufacturing sector. String a few months’ worth of these together and you will find yourself in the midst of a recession. Moody’s Analytics responded to the report thusly:

“U.S. manufacturing continues to struggle given the weakness in the global economy, past appreciation in the U.S. dollar, and trade tensions. The ISM manufacturing survey slipped from 48.3 in October to 48.1 in November, weaker than either we or the consensus anticipated.”

Dang! Bummer…to say the least.

But wait! We have this other attempt at reading the same data from the same economy. The sample and survey is different but it is trying to understand the same thing: the state of health of manufacturing. IHS Markit says this:

“November data indicated a faster rate of improvement in operating conditions across the U.S. manufacturing sector. ….. The seasonally adjusted IHS Markit final U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) posted 52.6 in November, up from 51.3 in October, to signal the strongest improvement in the health of the manufacturing sector since April.”

The IHS Markit press release (released to the same media outlets as was the ISM report) has this as its headline:

“November PMI at seven-month high amid stronger upturn in new orders”

And then offers a quote from the boss:

“Chris Williamson, Chief Business Economist at IHS Markit said: “A third consecutive monthly rise in the PMI indicates that US manufacturing continues to pull out of its soft patch. New orders and production are rising at the fastest rates since January, encouraging increasing numbers of firms to take on more workers. Exports are also back on a rising trend, firms are buying more inputs and re-building inventories, adding to the signs of improvement.”

And yet, nearly every outlet for financial news took the Institute of Supply Management number, ran with it and ignored the contradicting IHS number. What makes this more frustrating is that the IHS Markit survey tends to be (historically) a better predictor of where things are going. A possible reason for that is that the ISM survey — which has been around forever — surveys only its own members, most of whom are very big companies. There’s a potential bias in that. Those very big companies (also known as Large-Caps) tend to be global in their operations — much more than mid and small companies. As a consequence, they are more likely to be affected by the global economy than the US domestic one. IHS Markit’s survey has a survey population that is much closer to the actual distribution and range of the various company sizes within the friendly confines of America. That’s especially important when looking at US domestic manufacturing. Although we still say it’s a good idea to look at both reports, if we had to choose one, we would favor Markit’s.

– Read More…