IHS Markit and Institute of Supply Management published May PMI data a couple of weeks ago. PMI acts as a leading indicator and gives us a sense of what is coming.
May’s PMI numbers were not very encouraging. The manufacturing PMI released by IHS Markit came in at 50.5, the lowest since September 2009 when the economy was just trying to come out of the shadows of the global recession. While the reading still indicates expansion, the pace of expansion is the lowest in almost a decade. A reading above 50 indicates expansion, while a reading below 50 points to contraction.
Inflation running low
Inflation has been below the Fed’s target for a while now. While low inflation keeps your costs low, it also effectively caps the upside. Consider this. In a low inflation environment, most companies won’t have the flexibility to raise profits by raising prices. Thus, they will have to find more customers to earn more profits or sell more stuff to existing customers. Moreover, at the current low unemployment rate, workers may demand wage increases that top inflation, which could dent companies’ profitability.
The slowdown in manufacturing activity and low inflation point to stress in the stock market. Bonds are a better hedge against low inflation than equities. Thus, bond ETFs like the iShares 7-10 Year Treasury Bond ETF (IEF) and the iShares 20+ Years Treasury Bond ETF (TLT) may fare better than equity ETFs like the SPDR S&P 500 ETF (SPY). The SPDR S&P 500 ETF tracks the S&P 500 Index.