Crescenzi: ISM May Be Game Changer--With Some Caveats
Senior VP, Strategist, Portfolio Manager Pimco
I have been noting over the past couple of months the likelihood that the Institute for Supply Management's monthly purchasing managers index would increase to 50.0 or higher, offering the prospect of a rebound in share prices and placing Treasuries at risk of another setback.
This idea was based on the strong historical correlation between retail sales and the ISM index.With the ISM index having moved to 50.2 in June and marking the first time since January that the index was above 50.0, the chance at a rebound in the prices of risk assets has increased. The problem, of course, is the price of oil and other commodities, and the still-unknown effects of the credit crisis on the real economy. Hence, the ISM's rebound provides a foundation for a change in market sentiment, but it is a very shaky foundation.
A rebound in the ISM could turn a vicious cycle of self-reinforcing decreases in production, income, and spending, into a virtuous cycle of self-reinforcing increases. As companies raise output, incomes will raise, boosting spending and setting off another round of increases in production, income, and spending. Such is how economic expansions are underpinned. The current rebound will be tainted by doubts about its sustainability, but there is still a chance it latches on. Whether it does depends on oil and the impact of credit on the economy.
The other bankable idea I have been noting is that there will be a rise in consumer confidence following the presidential election. Confidence has almost always gained in the aftermath of a presidential election, as the nation tends to look ahead and be more optimistic about the future. This is even more likely to happen this time around given the current level of the public's discontent. This will help lower the equity risk premium and boost economic activity. (See Crescenzi debate the current state of the economy in the video).
As for oil, note that each dollar increase in the price of oil saps about $5 billion from the U.S. economy (20.5 million barrels x 365 days, adjusted for income earned from domestic producers). Hence on days like today, with oil up $2.5 per barrel, another $12.5 billion has been siphoned from real GDP. That's a large tally when considering that personal income increases a relatively smaller $1.7 billion per day.
It is immensely difficult to predict where the price of oil will go next, which complicates the always challenging task of predicting where the economy and markets will go next. The very definition of low inflation, which is something both Main Street and Wall Street miss sorely, is an inflation rate that is low enough that it does not interfere with decision-making.
Today, decision-making has been upended, with consumers and businesses uncertain about the future and hence unable to plan. Unless this is alleviated a rebound in the prices of risk assets will be delayed. If oil retreats, aided by extremely bearish sentiment the events I mentioned will have a powerful effect and spark a vigorous rally in risk assets and renewed weakness in Treasuries.
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Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the co-author of the just-revised "The Money Market" and "The Strategic Bond Investor."