Is Micro Weakness Smelling A Macro Collapse?
Last week we suggested a reason why the market was unable to hold on to the Bernanke bid. The relative plunge in Goldman Sachs 'bottom-up' Analysts Index (GSAI) suggested that the macro 'strength' that market-savants were so focused on, could perhaps be election-biased (blasphemy). It seems this macro 'strength' divergence (highest since 1996!) from micro 'weakness' reality was enough to get the Goldmanites thinking - and unfortunately for all the cautiously optimistic managers out there, they are not hopeful. As Jan Hatzius explains, "the GSAI remains closely correlated with other bottom-up measures, including the S&P 500 sales guidance diffusion index; and while one possible explanation is that S&P 500 companies are more exposed to non-US demand than the US economy at large, and the US has been a relative outperformer. But it is unclear whether this accounts for all of the weakness, or whether the bottom-up weakness also holds some additional leading information for the macroeconomic data."
Via Goldmans Sachs' Jan Hatzius:
- Our Goldman Sachs Analyst Index (GSAI)—which is based on our equity analysts' assessment of conditions in the industries they cover—has sharply underperformed the macroeconomic data, to a degree not seen since its inception in 1996.
- Has the GSAI gone off track? We don't think so, as it remains closely correlated with other bottom-up measures, including the S&P 500 sales guidance diffusion index compiled by our Portfolio Strategy group. It seems that the bottom-up message is simply gloomier.
- One possible explanation is that S&P 500 companies are more exposed to non-US demand than the US economy at large, and the US has been a relative outperformer. But it is unclear whether this accounts for all of the weakness, or whether the bottom-up weakness also holds some additional leading information for the macroeconomic data.
Since 1996, we have conducted a monthly poll of the Goldman Sachs equity analysts about business conditions in the industries under their coverage. In general, the resulting Goldman Sachs Analyst Index (GSAI)—a weighted average of analyst diffusion indexes for orders, shipments, and other activity measures—has matched macroeconomic indicators such as the ISM manufacturing and non-manufacturing index quite closely, and has at times even provided leading information. Partly for that reason, we typically release the GSAI two days before the ISM manufacturing index.
Over the past year, however, the historical relationship between the GSAI and the ISM has weakened, and anyone who has tried to use the GSAI to get an early read on the ISM has been disappointed (see Exhibit 1). The October 2012 release was the most striking example. The GSAI fell to 32.9, a reading that historically would have been consistent with an all-industry ISM in the mid- to high 40s. However, the all-industry ISM was broadly flat at 53.9.
Exhibit 1: Relationship between GSAI and ISM Has Weakened
What lies behind this divergence? One possible explanation is that the GSAI has simply become a less useful indicator over time, perhaps because of fluctuations in the sample size or divergence between our analyst coverage and the broader equity market. But on closer inspection, it seems that the weakness in the GSAI can be explained by more fundamental factors. While it has departed from the ISM, its weakness matches other "bottom-up" measures of economic activity quite closely, as also noted by our European Portfolio Strategy team. A good example is the revenue guidance index compiled by our US Portfolio Strategy group. It is defined as the percentage share of S&P 500 companies that guide consensus revenue estimates higher minus the percentage share that guide consensus estimates lower. Exhibit 2 shows that the GSAI has tracked the revenue guidance index closely since the latter was introduced in 2006, and both have weakened in lockstep in the past year. It seems that the bottom-up message from S&P 500 companies and the analysts that cover them is simply more negative than the macro data would suggest.
Exhibit 2: GSAI Still Tracks Revenue Guidance Closely
It is less clear why the bottom-up message is so weak. One reason is probably that S&P 500 companies are more exposed to international factors than the US economy as a whole, and non-US economies have slowed more sharply than the US. Regarding the first point, non-US sales account for 33% of the total sales of S&P 500 companies, but exports account for only 14% of US GDP. Regarding the second point, Exhibit 3 shows that the all-industry non-US purchasing managers index (based on data from our Global Economics group) has underperformed the all-industry ISM index for the US over the past year. Moreover, Exhibit 4 shows that while the GSAI has underperformed the composite ISM sharply, it has actually tracked the new export orders sub-index of the ISM (which is not included in the composite) reasonably well.
Exhibit 3: Weaker Conditions Outside the US
Exhibit 4: GSAI Still Tracking ISM Exports Closely
At the same time, the domestic/foreign split is probably not sufficient to explain the entire micro/macro divergence. Although there is little evidence for a systematic lead/lag relationship between the micro and macro data, and although other measures of overall activity such as the labor market and various GDP-type spending measures also point to decent growth, the micro data do provide an independent read on activity and may be pointing to slower growth ahead. Our forecast remains for a deceleration in real GDP growth to a 1.5% pace in early 2013, despite positive bounce-back effects from both Hurricane Sandy and the 2012 droughts. The main reason lies in the step-up in the pace of fiscal restraint and the uncertainty effects that may already have started to hit capital spending.
It is possible that indicators such as the GSAI and S&P 500 revenue guidance have picked up signs of such a slowdown at an earlier stage than the macroeconomic indicators.