The Purchasing Managers’ Index (PMI) is a well-known economic indicator. The results of the PMI surveys are widely used by investors, economists and policymakers to gauge changes in macroeconomic conditions across specific countries and sectors. Published monthly, these indices are backward-looking and provide insights into various company indicators. These include output, new orders, employment and prices charged based on company experiences. But are investors right to focus most of their attention on this set of data? Or can PMIs provide alternative insights?

Future Activity PMIs: forward-looking indicators

The S&P Global PMI survey also includes a unique indicator not based on past performance: the Future Activity PMI. This captures companies’ opinions and expectations for the next 12 months, making it more forward-looking. Can it predict investment returns linked to corporate performance? Logically, Future Activity PMIs should be a decent measure of corporate confidence. Leveraging the comprehensiveness of the broader PMI surveys, they could potentially be a good predictor of generic changes in corporate activity and demand. Significant changes in these PMIs can affect corporate bond credit spreads (e.g., a fall in activity could lead to lower cash flows and, therefore, weakening credit metrics).

Backtesting and findings

To our knowledge, no one has published any backtesting data on whether future activity PMIs can help support investment decisions in corporate bond investing. Motivated by the forward-looking nature of our credit research process, we performed some backtesting against broad credit spreads at the index level. Our findings indicate that for some markets, Future Activity PMIs can provide a useful trading signal for credit investors.

We focused on the Eurozone Composite Flash Future Output PMI (not seasonally adjusted), as published by S&P Global. We examined whether changes in this Index could predict changes in the spreads of European investment-grade corporates (excluding financials). The composite Index was selected to better match the mix of both services and manufacturing corporate debt issuers in the credit universe.

Interpreting PMI levels and trends

While the absolute level of PMI indices provides signalling information (with readings above 50.0 indicating an increase and readings below 50.0 indicating a decrease), we focused on changes in the monthly readings. We analysed the second derivative of the time series to identify turning points in the underlying data. Using data from 2012, we formulated a threshold level to identify trading opportunities (‘add’ risk or ‘sell’ risk). Once triggered, we examined the most recent trend in the data. An increasing trend signalled to add risk (i.e., expecting company performance to improve and credit spreads to contract). A decreasing trend signalled to sell risk.

Performance over time

Our analysis is summarised in the two charts below. The first shows the option-adjusted spread for Bloomberg’s Euro Aggregate Corporate Index (excluding financials) against the monthly future output PMIs for the eurozone. This comparison illustrates where spreads are relative to the absolute levels of the PMI over time. The second chart overlays spreads with the triggers derived from the change in PMI analysis. 

If an investor had relied solely on these signals since 2012 (ignoring liquidity, trading costs, etc.), then they would have benefited over this period. However, the signal is not perfect, and there were periods of underperformance. For example, the PMI trigger correctly identified a ‘buy’ (‘add’ risk) at the end of 2012, when euro investment-grade spreads were approximately 140bps. Spreads subsequently reached approximately 70bps in 2015, but no ‘sell’ (‘sell’ risk) signal was generated until July 2016. Given some signal volatility, this was flipped to ‘buy’ a month later. The triggers to ‘sell’ in March 2018 and ‘buy’ in January 2019 worked well. While the ‘sell’ trigger in 2020 came after significant spread widening, the approach did suggest re-adding risk soon after. Performance in 2021 was weaker, but the ‘sell’ signal in March 2022 and subsequent ‘buy’ signal in August 2022 were beneficial.

Enhancing investment decisions

A critic might argue that similar trading signals could be derived purely from the spread time series itself (i.e., trading levels: sell low, buy high spreads). However, even with this strategy, there's a risk of mistiming when to ‘add’ or ‘sell’ risk. We believe the PMI triggers can complement these investment decisions, introducing a forward-looking linkage reflecting possible corporate confidence and performance to a purely systematic mathematical approach.

Present market conditions

There has been no trigger generated since 2022. That signal suggested adding risk and, since then, spreads have tightened approximately 65bps. At the time of writing, there was much commentary about current spreads being ‘expensive’. But the charts show spreads could still tighten further. Some investors may be tempted to reduce risk. However, the absolute level of future activity PMIs and the level of recent changes suggest there might be a better point in the future to adjust positions.

Final thoughts…

PMI data, particularly Future Activity PMIs, can provide valuable insights for credit investing. By offering forward-looking indicators of corporate confidence and performance, they can complement traditional investment strategies, enhancing decision-making and potentially improving returns in the corporate bond market.

abrdn has over 70 people involved in credit research globally, and the insight and experience to navigate all market conditions. This enables our strong investment grade and private credit offering.