The forecast here at the start of the year was that the global manufacturing PMI new orders index – a key indicator of industrial momentum – would reach a peak in early 2021 and fall into the summer. The index declined slightly between November and February but rose to a new recovery high in March, with flash data last week and today’s Chinese results indicating a further significant increase in April. What has gone wrong?

The expectation of an early 2021 peak and subsequent relapse was based on a fall in global six-month real narrow money growth from an extreme peak in July 2020 – real money growth has led turning points in PMI new orders by 6-7 months on average historically. Six-month real narrow money momentum continued to weaken into March, so the monetary signal for PMI direction remains negative – see first chart.

Chart 1

There was meaningful variation around the 6-7 month historical average lead time. An April PMI new orders peak, were it to be confirmed, would imply a nine-month lead, which would be within one standard deviation of the average. So the further rise into April is not yet an unusual departure from the norm.

The most likely explanation is that the PMI upswing has been extended by US fiscal stimulus – particularly the third round of payments to households – along with initial moves towards economic reopening in the US, UK and other countries showing progress in virus containment. A 9.3% monthly surge in US retail sales in March may have been a key driver of stronger March / April new orders.

“Economic impact payments” authorised by the American Rescue Plan Act were $318 bn in March and $51 bn through 28 April for a total $369 bn, representing the bulk of a programme costed at $411 bn by the Congressional Budget Office.

New York Fed analysis of data collected in its monthly survey of consumer expectations indicates that households have spent or plan to spend 25% of the windfall, similar to the proportion in the first and second rounds, with remainder used to increase savings (42%) or pay down debt (34%). Rounding the $369 bn received to date up to $400 bn, this suggests additional consumer outlays of about $100 bn.

Assume that half of this amount is spent on goods, which could be an overestimate given that services account for two-thirds of total consumption. That would suggest additional retail sales – a rough proxy for goods spending – of about $50 bn. Monthly sales jumped by $47 bn between February and March. The suggestion is that the bulk of the boost to goods spending has already occurred and sales will fall back sharply into the summer.

Chart 2

An additional technical explanation for the March / April rise in PMI new orders is a positive base effect from the slump in the index to a low in April 2020. Survey respondents are asked to draw a comparison with the previous month but there is evidence that some replies take into account the level of business in the same month a year earlier – understandable in cases where there is a strong seasonal pattern in demand.

Specifically, a regression of the global manufacturing PMI new orders index on its one- and 12-month lagged values finds a small but statistically significant negative coefficient on the latter*. The coefficient suggests that a 13.7 point plunge in the index in March / April 2020 contributed 0.8 of a point to the estimated 3.0 point increase in March / April 2021 – third chart. This boost will reverse by June, reflecting the recovery in the index after April last year.

Chart 3

With global real narrow money growth still moderating, the US fiscal boost probably passing its maximum and China still on a slow growth path pending PBoC easing, the forecast here of a PMI pullback through late Q3 is maintained.

Chart 4

*The same result is obtained using US ISM manufacturing new orders data over a much longer sample.

The consensus has swung from pessimism about prospects for corporate profits in 2020 to likely excessive optimism now. Analysts, in particular, may underappreciate the contribution to recent profits resilience of government subsidies, withdrawal of which may offset much of the benefit of economic normalisation.

Posts here last year suggested that global profits would mirror V-shaped rebounds in retail sales and industrial output. S&P 500 aggregate operating earnings are likely to have risen above their pre-pandemic peak in Q1 2021, based on results to date and analyst estimates, according to S&P. Analyst forecasts imply growth of 29% between Q1 and Q4 2022 – see first chart.

Chart 1

S&P 500 operating earnings are equivalent to about 60% of corporate post-tax economic* profits in the national accounts and the two series follow a similar path. An attribution analysis, however, is available for the national accounts measure, allowing the recent contribution of higher subsidies and reduced taxes on production to be separated out.

As of Q4 2020, national accounts profits were 2.4% below their pre-pandemic peak in Q4 2019. If subsidies / production taxes had remained unchanged, the shortfall would have been 19.8%. Put differently, the rise in subsidies accounted for 17.8% of the level of profits in Q4 2020.

This direct contribution of government to profits will normalise as the economy reopens and emergency programmes are withdrawn. Assuming that the rise in subsidies since Q4 2019 is reversed, “underlying” profits – excluding the recent additional support – would need to grow by 21.7% from their Q4 2020 level to maintain overall stability. The consensus forecast of a 29% increase in S&P 500 operating earnings between Q1 2021 and Q4 2022, therefore, could require underlying growth of more than 50%.

Data later this week will show that GDP almost regained its pre-pandemic level in Q1 2021 and the FOMC’s median projection implies a further increase of more than 8% by Q4 2022. Adding in inflation at 2-3% pa suggests nominal GDP growth of about 13% – unlikely to support profits expansion of 50%.

Profit margins, indeed, could be squeezed by rising labour costs. The view here has been that the labour market would return to pre-pandemic levels of tightness by late 2021, resulting in upward pressure on wage growth. Labour market responses in the April Conference Board consumer survey support the view that conditions are normalising rapidly – second chart.

Chart 2

National accounts data for other G7 countries are less detailed / timely than for the US but government subsidies are likely to have provided similar or larger-scale support for profits. In the UK, the economy-wide gross operating surplus** would have been 13.0% lower in Q4 2020 without additional government subsidies / lower production taxes – third chart. The extra support amounted to 5.0% of GDP in Q4, double the equivalent in the US, reflecting the “generosity” of the UK’s furlough scheme.

Chart 3

*”Economic” = including inventory valuation and capital consumption adjustments.
**This is not comparable with the US national accounts profits measure – it is gross of depreciation, interest and income taxes and includes non-corporate business income.