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PMI survey data provide an accurate advance guide to corporate
earnings growth
EPS gauge is derived from survey indices measuring sales,
pricing power and profitability
First quarter earnings momentum at three-year low
The US PMI surveys produced by IHS Markit provide a valuable
advance insight into economic trends, but also act as a reliable
indicator of corporate earnings. With the first quarter earnings
reporting season about to start, we look at the signals from the
recent surveys.
Manufacturing-led slowdown
The surveys indicate that growth has moderated since the robust
gains seen this time a year ago, especially in the goods-producing
sector. The
'composite' index, which pulls together the data from the
manufacturing and service sector PMIs and acts as an accurate
'nowcast' tool for GDP, correctly indicated that the pace of
economic growth slowed in the fourth quarter (our model from the
survey indicated 2.5% growth against an initial official estimate
of 2.6%). The index has since shown no re-acceleration in the first
quarter (see fig 1).
Businesses in fact reported that output growth eased to the
second-lowest seen over the last year, according to the flash PMI
results for March. Although the headline PMI remains encouragingly
resilient, indicative of the economy growing at an annualised rate
in excess of 2% (suggesting some potential upside to many current
growth forecasts), signs of the business environment becoming
tougher have intensified in recent months, especially in
manufacturing, where the survey is consistent with falling
factory output and order books (see fig 2).
Weaker forward-looking indicators
Growth is also likely to cool further, according to the survey's
sub-indices, and companies may soon seek to reduce capacity.
Whereas new orders were growing at a faster rate than companies
could boost output throughout much of last year, the surveys are
now showing signs that demand is insufficient to sustain current
output levels. Similarly, in manufacturing, the forward-looking new
orders to inventory ratio hit a 18-month low in March and
suppliers' delivery delays (a key indicator of capacity
utilisation) indicated the fewest delays for 16 months in
March.
At the same time, business optimism about the outlook has also
cooled to the lowest since mid-2016 amid worries over the impact of
tariffs, trade wars, higher prices and rising interest rates.
Earnings under pressure
The headwinds to business indicated by the surveys bode ill for
corporate earnings growth, a deeper insight into which can be
gleaned from analysis of other survey sub-indices against
historical earnings growth. In this respect, the surveys indicate
that earnings have been under their greatest pressure for three
years in recent months.
IHS Markit PMI earnings indicator
components
To estimate the trend in earnings growth we have compiled an
indicator based on five components, all derived from IHS Markit's
US PMI surveys, which provide insights into sales growth, pricing
power and profitability:
Total order book situation: a blended index of
the composite new orders and backlogs of orders questions providing
an overall indication of sales growth (weight 1.3)
Output prices: based on the composite PMI
average prices charged index, providing an indication of pricing
power among goods producers and service providers (weight 0.7)
Backlogs of work: the composite survey index
covering work received but not yet completed, which helps indicate
the extent to which demand is running ahead of capacity and
therefore acts as a further guide to both sales and pricing power
(weight 0.7).
Productivity: the ratio between composite PMI
output and employment indicators which provides an insight into
labour productivity, itself a key determinant of profitability
(weight 0.2)
Suppliers' delivery times: a key gauge of
capacity constraints and pricing power (weight 0.3)
The above components are calculated by first comparing the
current month's value to the trailing six-month average. The
components are charted here against earnings growth (note that in
these charts we use three-month averages to illustrate the trends).
We compare the components against the reported earnings per share
in S&P500 companies over the prior 12 months, as measured by
Case Shiller, and specifically the current month's EPS value
against the prior six-month trailing average.
Individual components are then weighted together to form a
composite earnings momentum gauge (see fig 3). The resulting index
exhibits a correlation of 75% against this measure of earnings
growth with an advanced lead of four months, which rises to 83% if
a moving average is used to reduce some of the indicator's
volatility.
The average earnings growth momentum signalled by the indicator
in the first quarter is the lowest recorded since the first quarter
of 2016, a time when earnings were falling at an annual rate of
12.9%.
Please note that the indicator is merely designed to provide a
simple guide to earnings trends, and further research may yield
higher correlations and improved predictive ability. Further work
can also be undertaken to analyse the PMI signals by sector, using
IHS Markit's Sector PMI dataset.
For more information contact economics@ihsmarkit.com.
Chris Williamson, Chief Business Economist, IHS
Markit
Tel: +44 207 260 2329
chris.williamson@ihsmarkit.com
Purchasing Managers' Index™ (PMI™) data are compiled by IHS Markit for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies, and are available only via subscription. The PMI dataset features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as GDP, inflation, exports, capacity utilization, employment and inventories. The PMI data are used by financial and corporate professionals to better understand where economies and markets are headed, and to uncover opportunities.
