Last week, manufacturers reported on both the New Orders for Durable Goods and the Purchasing Managers’ Index (PMI) for manufacturers. This comparison between Durable Goods Orders and PMI has been ongoing since February 1982.
A widely accepted belief is that when the PMI falls below 50, it predicts recessions. However, recent data challenges the reliability of this indicator, especially in the current economic climate.
Historical records show that the PMI falling below 50 has sometimes coincided with recessions, but it has also been inaccurate in other instances. The correlation between the PMI and slower periods in Durable Goods Orders is not perfect either.
Despite the PMI forecasting a recession since late 2023, Durable Goods Orders have been steadily increasing, leading to a significant divergence between these two series.
The spike in Durable Goods Orders can be attributed to the economy recovering from COVID lockdowns and various supply chain disruptions. Demand for air travel and lightweight vehicles in the US has significantly contributed to the surge in Durable Goods Orders.
Key drivers such as Real Retail Sales, employment, and Real Personal Income continue to remain at favorable levels. As long as these indicators show no signs of decline, the US Real GDP is expected to rise, along with associated equity prices.
It is important to recognize that the PMI is a sentiment indicator and should not be considered a primary economic measure. Its track record of forecasting recessions is overstated, with more instances of false alarms than accurate predictions. This disparity is particularly pronounced in the current period.
Instead, investors can view low PMI levels as an opportunity to purchase equities at lower prices, taking advantage of the mismatch between market sentiment and economic fundamentals.
During the current period of equity weakness, investors can effectively allocate capital to well-managed companies that are undervalued compared to their historical pricing. This strategy allows for outperforming the overall market, despite the influence of highly favored issues with inflated prices.