Party like its 1999 - A Late cycle resurgence

In the financial markets, participants are always looking for analogies or historical examples to glean information from. Technical analysts look for chart patterns, value investors prefer a process and often talk of "checklists" and algorithmic traders follow a set of rules most often optimized or at least tested on historical data. Practice makes perfect in most areas of life and participating in financial markets is no different. However sometimes the inexperience of youth can be a blessing, as there are no "bold and old" traders on Wall Street and many Nobel Prize winners did their best work when they were young. So always remember there are lots of ways to skin a cat in this business. Moving on.

Wednesday's ISM headline number missed expectations coming in at 55 vs 56 expected but still increased from December. If you are going to focus on one economic statistic, I think ISM is probably it. Even though its released from a non government agency, it has data going back to 1948, is widely used in many quantitative models and most importantly gives an up to date reading of "supply management professionals", those managers highly attuned to the current business cycle. You can find more information regarding the release along with some interesting anecdotal comments directly from the ISM website.

---

WHAT RESPONDENTS ARE SAYING …

“Demand very steady to start the year.” (Chemical Products)

“January revenue target slightly lower following a big December shipment month.” (Computer & Electronic Products)

“Strong start to the new year. Production is increasing and we are adding capacity.” (Plastics & Rubber Products)

“Business looks stronger moving into the first quarter of 2017.” (Primary Metals)

“Economic outlook remains stable and no current effects of geopolitical changes appear to be penetrating market conditions.” (Food, Beverage & Tobacco Products)

“Sales bookings are exceeding expectations. We are starting to see supply shortages in hot rolled steel due to the curtailment of imports.” (Machinery)

“Year starting on pace with Q4 2016.” (Transportation Equipment)

“Business conditions are good, demand is generally increasing.” (Miscellaneous Manufacturing)

“Conditions and outlook remain positive. Raw material prices are stable resulting in stable margins. Asset utilization remains high.” (Petroleum & Coal Products)

“Steady demand from automotive.” (Fabricated Metal Products)

---

The headline index is a composite index which includes various sub indexes on Prices Paid, Inventories, New Orders, Employment, to name a few.  Below is a chart of the New Orders Index, resized so that a reading of 50 is plotted at 0, given that 50 is typically used as the difference between expansion vs contraction for this survey. 

The circles in red denote recent times where New Orders did a quick dip below 50, only to bounce back hard, outside of a recession. The observation in 1998/1999 coincided with the LTC/Russian Ruble/Asian Tiger disaster, 2012 with the Euro Crisis and last year with the Oil/EM debacle. 

What is interesting to note is that these observations occurred in what can be characterized as a latter stage of the economic cycle (though 2011 was far less than last year). However given the nature of the ISM survey, which essentially asks managers about their business activity on a month over month basis, the series tends to rebound quickly, peak and then go lower. Its mean reverting by nature as business conditions often don't get better/worse month after month for too long. 

We can see the ISM New Orders index bottomed in October of 1998, at 48 and then peaked in September/November of 1999 almost a year later at 63. Notably, when the US Equity market peaked in March of 2000, the New Orders index was already down 7 points from the high, at 56.2.

If we look at the 1998/1999 experience as a guide for today's market that would imply that the December 2015 low of 48.8 has probably made a high ~ 12 months later, at the last two readings of 60.3 & 60.4. While history never repeats exactly, it often rhymes.

Btw, good times in 1999. I figured even the yougins know Prince's song. I doubt many here remember this ;)