The new orders component of the Institute for Supply Management's manufacturing Purchasing Managers' Index survey is widely considered among the best forward-looking indicators for the U.S. economy. The most recent report provided some unequivocally good news – the highest reading for new orders in a decade.
The challenge for equity investors is to translate these promising results into positive portfolio returns. A close look at market history suggests technology stocks, not industrials, are the best way to accomplish this feat.
The analysis started by comparing 10 years of monthly new orders data with the performance of each of the S&P 500's 10 major sub-indexes. The indexes with the highest correlation with manufacturing new orders were the S&P 500 Information Technology index and the S&P 500 Consumer Discretionary index.
The next step was to compare the historical new orders with the subsequent performance of these two indexes, to gauge whether it provided equity market signals. This is where consumer stocks fell off – changes in new orders had no correlation with subsequent equity performance for stocks in the sector.
Technology stocks, as shown in the chart below, were a different matter. The pattern is a bit choppy before 2012, but the past two years have seen new orders data provide an effective indicator of the three-month future performance of technology stocks. More importantly, the recent trend suggests that the sector is poised for a significant rally.
The key word here is "suggests." There is no guarantee that the relationship will hold. Nonetheless, investors looking to put money to work in the U.S. market should pay particular attention to the technology sector in light of the most recent trends in manufacturing new orders.
Follow Scott Barlow on Twitter @SBarlow_ROB.