ISM’s grim readings are a good indicator of a company’s earnings – but not what the stock market will do

I am not saying that the bear market is over. But if US stocks continue to fall, don’t blame the ISM’s recent downturn.

The Institute for Supply Management’s manufacturing index – the ISM index – is known as the Manufacturing Purchasing Managers’ Index, or PMI. The ISM reflects the results of a monthly survey of purchasing managers at hundreds of US manufacturing companies.

Economic calendar: Nonfarm payroll and unemployment data scheduled for Friday, along with a consumer credit update and more

This leading indicator of economic health currently stands at 52.8 – down from 63.7 in early 2021, and at its lowest level since the early days of the COVID-19 pandemic shutdown. As my MarketWatch colleague Jeffrey Bartash reports, this latest reading is “a sign of creeping weakness in the US economy.”

many The bears have pounced on this last reading As a reason to expect further weakness in the coming months. And they point out, with substantial supporting historical evidence, that corporate earnings tend to follow the ISM’s footsteps with an interval of several months.

But that certainly doesn’t mean stocks will follow. The current level of the stock market already includes the importance of bad earnings from the latest ISM report. The bears’ argument can only be justified if they can show that the market is systematically ignoring or misinterpreting this importance.

However, there is no such evidence. Consider what I found when measuring the correlation between the ISM index and the S&P 500 SPX index,
-0.16%.
Focusing on simultaneous changes in these two indicators, I found a significant positive correlation coefficient – 51.3% when correlating 12-month percentage changes since 1948, as you can see from the chart below. This is exactly what you would expect from a functioning stock market, rising and falling in conjunction with measures of economic activity.

In contrast, when correlating the ISM’s 12-month relative change with the S&P 500’s percentage change over the next 12 months, the correlation coefficient became negative—minus 12.4%, to be exact. This inverse correlation means that all too often, the stock market turns out to be above average after big dips in the ISM index – and vice versa.

To be sure, this inverse correlation has only marginal statistical significance. So it would be an exaggeration to conclude that the recent drop in the ISM is actually good news for the stock market. But the fact that it’s inverted at all shows that the stock market more or less immediately incorporates the full economic significance of the new ISM readings, and if anything, it’s a little overreacted.

Nobody is arguing that the US economy is not weaker than it was in 2021. It is without a doubt. But this weakness is already present in stock prices. The future trajectory of the stock market will be related to whether the economy in the coming months is stronger or weaker than currently expected.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to review. It can be accessed at mark@hulbertratings.com

Hear what Ray Dalio says at the Best New Ideas in Money Festival September 21-22 in New York. The hedge fund pioneer has strong views on where the economy is going.

more: ISM found that most US companies grew faster in July, in a sign of the economy’s resilience

Read also: FAANGs Aren’t What They Were Before, So Beware Of A Bearish Market Bounce As This Hedge Fund Manager Says

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