Always on the look-out for a silver-lining, the world's commission-taking asset managers are flooding into the new cleanest dirty shirt of European stocks (the more beaten-down, the better) - apparently on the basis of the exuberance in surging PMIs. Aside from the fact Draghi himself already poured cold-water on people's belief in the strength of the European recovery last week [11], and our note this weekend on the 'roughness' of PMI survey "soft" data [12], investors remain unmoved and momentum has taken over now. However, as Goldman explains some of the optimism on the basis of recent manufacturing PMIs may not square with evidence of a structural break in the link between the PMIs and growth. While a reading of 50 may in pre-crisis days have indicated positive growth on the periphery, it today may only indicate flat (or even negative) growth, as the external financing constraint prevents better sentiment from translating into activity.
Just as we noted here [12], the "soft" survery based data of the PMIs remains ignorant of the "hard" data such as unemployment, delinquencies, lending, and production...
[13]
Via Goldman Sachs,
Prior to the Euro zone crisis, “neutral” PMI readings of 50 tended to coincide with positive GDP growth on the periphery, so that this threshold could perhaps better be thought of as representing trend (or potential) growth. Prior to the Euro zone crisis, external financing was plentiful for the Euro periphery, which is no longer the case. As a result, trend growth on the periphery is likely to have fallen, so that whereas a PMI reading of 50 used to correspond to positive growth it might now correspond to trend growth of zero or even negative.
...
These results suggest that the signal from manufacturing PMIs to growth has deteriorated in the Euro zone, with better sentiment not translating the way it once did into activity. This deterioration in the signal from PMIs to growth is most pronounced for periphery countries (Italy, Spain, Greece and Ireland), which are now subject to an external financing constraint, while there is no evidence of a similar break for Germany and France. Intuitively, this suggests that while better sentiment continues to translate into higher activity in the core, on the periphery better sentiment may not be able to, because entrepreneurs are unable to raise external financing to put their ideas into practice.
...
We conclude that some of the optimism on the basis of recent manufacturing PMIs – which is one of the factors that has been driving Euro zone interest rates higher – may not square with evidence of a structural break in the link between the PMIs and growth. While a reading of 50 may in pre-crisis days have indicated positive growth on the periphery, it today may only indicate flat growth, as the external financing constraint prevents better sentiment from translating into activity.