Recently we’ve been seeing positive readings from the Purchasing Managers’ Index (PMI), news that may seem as though it would be good for all stocks. In fact, though, a look at the performance of the S&P 500 and the PMI since 1995 shows that this is not necessarily the case.

S&P 500 Standardized Return vs. PMI Trend*

http://editor.des08.com/heartland-advisors/SP_PMI.jpg

Source: CL King & Associates, 1/1/1995 to 12/31/2012

We would expect to see a more negative trend in the S&P 500’s returns when the PMI is at lower levels, and a more positive one when the PMI is higher or on an upward trajectory.

Instead, there appears to be no discernible, consistent connection between the two indices.

This is in part because the broad-based stock index includes a number of sectors and industries, such as Health Care, Financials, and Retail, whose activity isn’t directly reflected in the PMI. There are, however, some areas of the market that have established a strong correlation with this leading indicator. For example, Industrial Machinery stocks have typically generated above-average returns at times when the PMI is above 50—the level associated with good economic health.

Industrial Machinery Standardized Return vs. PMI Trend*

http://editor.des08.com/heartland-advisors/Industrial_PMI.jpg

Source CL King & Associates, 1/1/1995 to 12/31/2012

Of course, a history like this on its own isn’t enough to serve as a ‘buy’ signal for stocks in this, or any sector. But it can help to identify pockets of opportunity where undervalued, financially sound companies might reside. Such trends might also provide the catalyst for growth that ultimately allows the market to fully recognize these companies’ value.

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*To create these graphs, every month since January 1, 1995 was classified into one of the following eight categories based on the trend in the PMI versus the prior month: 1) <=45 & rising; 2) 45-50 and rising; 3) 50-55 and rising; 4) >=55 and rising; 5) >=55 and falling; 6) 50-55 and falling; 7) 45-50 and falling; 8) <=45 falling. Total returns for the S&P 500 and the S&P 500 sub-index for Industrial Machinery for each month during the same periods were then calculated. All the monthly total returns were then standardized, and the average for each category calculated.

Past performance does not guarantee future results.

The value an investment will vary from day to day in response to the activities of individual companies and general market and economic conditions, which may cause loss of principal.

For Financial Professional Use Only.

© Heartland Advisors

www.heartlandfunds.com

© Heartland Advisors

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