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A fresh reading on global manufacturing activity for October provides two important takeaways for Canadian investors: One, the sharp decline verifies the painful slide in global mining stocks, and more importantly, it also likely suggests that bond yields are headed lower.

The monthly JPMorgan Global Manufacturing PMI index, released on Friday, is an excellent way to check for mispricing in industrial metals prices and, by extension, domestic mining stocks. The data are backward looking so they can’t provide a leading indicator. But when metals prices in aggregate diverge from changes in global manufacturing activity, it is often a sign that speculative excess in metals markets – bullish or bearish – is creating investor opportunities.

The first accompanying chart compares the year-over-year change in the JPMorgan Global Manufacturing PMI with the S&P GSCI Industrial Metals Index. The two lines have tracked closely together in recent years, and Friday’s weak PMI results suggested that October’s sharp decline in metals prices was warranted.

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The second chart is from Andrew Garthwaite, a prominent strategist at Credit Suisse. It compares the forward-looking portion of the global manufacturing survey – new orders for goods – with the 10-year U.S. Treasury yield. From a 2017 high over 55, the new orders index is now approaching the 50 level. An index reading below 50 indicates a worldwide contraction in manufacturing activity.

Mr. Garthwaite writes, “We have seen the largest decoupling between global PMI new orders (falling) and real bond yields (rising) since 2007 … if growth slows in line with global PMIs, we think U.S. bond yields will start to fall …”

Rising U.S. bond yields, and a subsequent strong U.S. dollar, are the primary culprits behind the recent market weakness. This makes a reversal in trend – falling bond yields – a big deal for investors.

The most widely agreed upon definition of a stock’s correct price is the discounted value of future cash flow and dividends. Bond yields act as part of the risk-free discount rate (they are part of the formula in calculating the “discounted,” or present value, of future cash flows) so the higher yields go, the less all stocks are worth. The falling yields Credit Suisse expects have the reverse, and far more positive, effects on asset prices. Declining yields also make dividend stocks more attractive and act as a boost to the value of income-paying equities.

Domestic bond yields have closely tracked their American counterparts over the past two decades – the average difference between Canadian 10-year government bond yields and 10-year Treasury yields is a minuscule 6.7 basis points (monthly data since 1998). Canadians, then, can expect falling U.S. yields to put downward pressure on domestic yields also.

It is important to remember that divergences like those in the second chart can be corrected in different ways. In this case, 10-year yields can fall, PMI values can rise, or some combination of the two can see the two lines eventually meet in the middle. Each scenario has different investing implications.

Sharp slide

Year-over-year percentage change

S&P GSCI Industrial Metals Index

JPMorgan Global Manufacturing PMI Index (right)

50%

8%

40

6

30

4

20

2

10

0

0

-10

-2

-20

-4

-30

-40

-6

2014

2015

2016

2017

2018

PMI new-order index decoupling

from bond yields

Global PMI new orders

U.S. 10-year Treasury (per cent, right scale)

4.0%

59

3.5

57

3.0

55

2.5

53

2.0

51

1.5

49

1.0

47

2011

2013

2015

2018

THE GLOBE AND MAIL, SOURCE: CREDIT SUISSE

RESEARCH; SCOTT BARLOW

Sharp slide

Year-over-year percentage change

S&P GSCI Industrial Metals Index

JPMorgan Global Manufacturing PMI Index (right scale)

50%

8%

40

6

30

4

20

2

10

0

0

-10

-2

-20

-4

-30

-40

-6

2014

2015

2016

2017

2018

PMI new-order index decoupling from bond yields

Global PMI new orders

U.S. 10-year Treasury (per cent, right scale)

4.0%

59

3.5

57

3.0

55

2.5

53

2.0

51

1.5

49

1.0

47

2010

2011

2012

2013

2014

2015

2016

2018

THE GLOBE AND MAIL, SOURCE: CREDIT SUISSE RESEARCH;

SCOTT BARLOW

Sharp slide

Year-over-year percentage change

S&P GSCI Industrial Metals Index

JPMorgan Global Manufacturing PMI Index (right)

50%

8%

40

6

30

4

20

2

10

0

0

-10

-2

-20

-4

-30

-40

-6

2014

2015

2016

2017

2018

PMI new-order index decoupling from bond yields

Global PMI new orders

U.S. 10-year Treasury (per cent, right scale)

4.0%

59

3.5

57

3.0

55

2.5

53

2.0

51

1.5

49

1.0

47

2010

2011

2012

2013

2014

2015

2016

2018

THE GLOBE AND MAIL, SOURCE: CREDIT SUISSE RESEARCH; SCOTT BARLOW

Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market.

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