The economic calendar in recent days has given investors lots of reasons to be bullish. The March jobs report grabbed most of the headlines, but the latest manufacturing data may offer the best clue for the U.S. stock market.
First, to recap: the Institute for Supply Management’s March manufacturing purchasing managers index shot up to 64.7 in March from 60.8 in February, well past the 61.5 economists polled by FactSet had predicted. That result was the highest since 1983.
It’s worth revisiting the report during this light-data week. Ed Yardeni, president of Yardeni Research, notes that the year-over-year change in the S&P 500 stock price index (.SPX) is highly correlated with what he refers to as the M-PMI, also known as the ISM. That’s because the year-over-year growth rate S&P 500 companies’ revenues is highly correlated with the manufacturing index, he says, with the latest reading suggesting a surge in corporate revenue is in the offing.
“The M-PMI has been and continues to be bullish for stocks and bearish for bonds,” Yardeni said in a note to clients on Tuesday. While the reading was hot during March, he says it could get “red hot” in April as a result of the latest round of stimulus spending.
Consider liquidity data. While M1 and M2 money supply data are now available only monthly—until recently the stats, which reflect currency in circulation plus saving deposits and certain certificates of deposit and money-market deposits, were reported weekly—Yardeni points to a weekly series the Federal Reserve compiles for total deposits at commercial banks. That series rose by a record $2.9 trillion year-over-year through the week of March 17, around the time the U.S. Treasury started to issue the third round of pandemic relief checks. Meanwhile, Yardeni notes, the Treasury’s checking account at the Fed fell $247 billion over the past two weeks (through the March 31 week), as many households received checks and direct deposits of $1,400 per person.
“All that liquidity augurs for another strong, or stronger, reading in April’s M-PMI and a continuation of the bull market in stocks,” Yardeni says.
Digging into the March ISM report reveals strength below the surface. The new orders and production indexes hit the highest levels since January 2004. Supplier deliveries surged to the highest reading since April 1974, while the backlog of orders boomed to the loftiest level since reporting for that subindex started in early 1993. Demand is outpacing supply, and that dynamic doesn’t look like it will change soon.
There is an important flip-side. Producer prices remain elevated as the costs of everything from oil to lumber continue to rise. Over the past two months, the prices paid component of the ISM has hovered at its highest level since July 2008. Rising input prices should squeeze companies’ profit margins, Yardeni says.
Investors will get an update on that front Friday when the Labor Department reports its latest producer-price index. For March, economists expect a big 3.8% jump in wholesale prices from a year earlier (in February, prices increased 2.8% year over year). Policy makers have warned that year-over-year inflation numbers would get hot, but they say increases would be transitory.
Recent price increases by companies including Kleenex-maker Kimberly-Clark (KMB) suggest corporations don’t see higher input prices as quite so temporary. That’s potentially to the benefit of corporate profit margins, at least when it comes to the sellers of consumer staples and even if it’s a macro red flag for building inflation. Investors have to wait until next week, when the consumer-price index is released on April 13, to see the extent to which producers are passing on higher costs to consumers.
For now, though, investors can take comfort in the revenue side of the equation given the high correlations Yardeni observes between the M-PMI and both the S&P 500 stock price index and the year-over-year growth rate in S&P 500 company revenues. Looking at those, stocks have plenty of room to run.
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