Turmoil in Cyprus hogs the headlines, but problems closer to home could have potentially serious consequences for investors here. The key Markit Eurozone Manufacturing Purchasing Managers' Index (PMI) fell to a three-month low in March turning Europe's finance ministers ashen-faced. Italy and Spain were especially disappointing and even mighty Deutschland flashed red, leaving the PMI down at 46.8 points from an already weak 47.9 in February. The indicator has been stuck below the 50-points boom-bust line since August 2011, yet equity markets are trading at levels consistent with growth rather than contraction and share prices look vulnerable.
These grim numbers got Deutsche Bank strategist Jim Reid thumbing through the history books and his conclusions are worrying. Using data going back to the late 1990s, Mr Reid finds a clear correlation between the PMIs and year-on-year changes in equity markets that's been a reliable guide to market performance. "Rarely do the two variables stay out of line for long, something normally gives," he says. According to his sums, US equities are trading 7 per cent above where the ISM suggests they should be, while the UK and Spain are both 13 per cent higher than levels implied by their PMIs. In Germany it's 14 per cent, Italy 19 per cent, and France a staggering 33 per cent.
Deutsche expects a "set back" some time during the second quarter unless things pick up. "If we don't see such an improvement over the next three months, risk markets in Europe will struggle to defy economic gravity," warns Mr Reid. "So it remains all about the data."
