Sunday, January 4, 2009

ISM and SPX

Vix and More has an excellent presentation in his chart of the week: ISM Plummets. The chart, modified below, captures the ISM and SPX from 1950. Vix and More highlighted how the chart was plumbing depths only seen three times before during the serious recessions of 1949, 1974-75 and 1980. Moreover, the most recent ISM report's new orders reading was lower than ay time in its 60 year history, suggesting further weakness ahead.

Wonderful chart, but one thing that struck me is how poorly correlated the ISM index is to stock market bottoms. Often, both SPX and ISM dip in the same year, but in general SPX bottoms before the ISM index reaches its lowest reading. In other words, ISM normally appears to lag SPX. I've highlighted numerous such examples in green.

Also, on multiple occasions, the ISM index dropped without a "large" drop in SPX. In these occasions ISM fails to predict SPX. Several of these examples are highlighted in blue.

There are occasions where the drop in ISM leads the drop in SPX. I've identified three, highlighted in red, which occurred in 1960, 1982 and 2002.

In general, drops in the ISM index do not appear to predict further stock market weakness. In most cases, SPX has already bottomed and is rallying by the time ISM makes a bottom. It would seem that equities had already anticipated the bottom in the ISM and had subsequently advanced. I would be cautious in using the ISM index to predict further stock market weakness.

Mind you, there are three examples where the ISM lead SPX down: 1960, 1982 and 2002. Maybe 2009 will play out like these years. Perhaps there is some common macro-economic link between these three events and today? The 1960 recession began with a housing bubble burst, 1982 was the Volker recession caused by high interest rates, and 2002 was part of the tech-bubble crash. If there's a link, it's not obvious to me.



One last observation. All three of these recessions, if you look closely, had stock market rallies between the first and final lows of the ISM index. In these cases, perhaps, equities failed to anticipate the continued weakness in the economy and subsequently fell again. Perhaps there is a common link with today's situation?

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