Based on pronouncements at last weekend’s meeting of the Group of Eight finance ministers, “green shoots” seem to be wilting somewhat, leaving investors questioning whether the recent reflation trade has not been getting ahead of itself.

The “less-bad-than-expected” school of thought is largely based on survey data such as the Purchasing Managers Indices (PMIs). It therefore makes for interesting reading to revisit the historical relationship between the PMI and stock-market movements. The example below shows the US composite (services and manufacturing) PMI plotted together with the 12-month percentage change in the S&P 500.



For some fun with numbers, I've done a regression analysis of the 2 series, resulting in an R² coefficient of 0.76.



Applying the regression results to a range of PMI assumptions, the expected changes in the S&P 500 are as shown in the table below.



The figures show that a “pessimistic” scenario of a stagnant PMI would result in a decline of 23.4% in the S&P 500 (i.e. an index level of approximately 700). Even a “realistic” scenario of gradually increasing the PMI by 1% per month between now and November would still result in the S&P 500 being 8.7% lower by the end of November. Interestingly, the stock market seems overpriced under all scenarios over the next few months and only reaches positive territory again in August under the “very optimistic” scenario and in November under the “optimistic” scenario.

And lastly, John Murphy (StockCharts.com) concurs, remarking:

“As good as the spring rally has been, I believe the market is still in need of some corrective action (or consolidation) before moving substantially higher. V bottoms are extremely rare. W bottoms are a lot more common. So are head-and-shoulder bottoms. It seems unlikely that the market will continue to rally in a straight line. More basing activity is most likely needed. And that's going to require more time.”