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.