Manufacturing PMI: My Next Rotation Picks

Most traders are taught to look at the headline PMI number.

Good traders track the trends in the PMI to figure out what is heating up or cooling down.

But,

The real opportunity comes from digging one level deeper.

It comes from understanding which industries are actually improving, which ones are weakening, and what that tells us about where capital could move next.

Last month, I took you through that exact process.

The PMI data pointed us toward Wood Products.

The result?

All while the AI trade, and the market, lost double digits during the same period.

Today we just got a new signal, and it confirms one of the themes I’ve been noticing in my daily digests.

The market is beginning to price in a “growth shock” scenario across the economy.

What happens next is a mix of broad equity de-risking, and aggressive rotations into the defensive areas that demonstrated the most growth during the month.

That’s what we’re about to get into in a minute.

In a nutshell:

This combination is the economic footprint of a growth shock, as most industries in the cyclical economy begin to pile up inventories ahead of time, locking in lower prices before they are charged a much larger quote.

Laws of capital apply here.

When you build up available inventories, and demand stays flat, your margins will eventually begin to tighten and so do your stock prices.

However,

Not all industries fall into this same contraction.

A couple are actually worth buying here.

Let’s get into it,

Manufacturing PMI: My next rotation picks.

Let’s begin by understanding what the PMI drivers are actually doing right now.

From September to October:

This is a combination of supply control tactics to help ease the growing lead times and bottlenecks, which in a way help control future price hikes.

On the other side of the equation, in demand, these tactics also have a significant side effect.

If businesses have enough (and even exceeding) inventory available, then there is really no need to keep ordering more from suppliers.

Therefore,

The rest of the attached supply chains slow down to a point where new orders, exports, and backlogs begin to be negatively impacted.

Just what we are starting to see above.

In fact, production just hit its highest output since November of 2021.

Let that sink in as prices also seem to be coming off the March highs as a result of the Iran war.

It’s hard to be bullish on a print like this, since it implies most industries are beginning to synthetically reduce demand to control prices through supply injection.

In other words,

This is not bullish for cyclical industries, which is why I’ve been more focused on defensives this month.

Click here to see my latest defensive buy with over 200% upside potential.

66% of comments were negative in October, while only 34% were positive.

However,

We must break apart what actually drove respondents to become more pessimistic this month:

The only improvements came from new orders and production this month.

Which makes sense.

If demand is easing on rising inventories, and production shifted from reactive to proactive, then sentiment is going to naturally become more positive.

Electronic components continue to drive the shortages across commodity markets, now being 20 months short with no ease in sight.

Unless, the slowdowns in data center expansion and the falling under of AI-related debts create a sudden supply shock as hundreds of millions worth of inventory hit the market all at once.

Then we have memory components being 10 months in shortage, and prices going up for 8 consecutive months as well.

Considering the DRAM complex, like Micron and SanDisk, are now trading well into bear markets, I would say last month’s memory price data is going to be challenged next month.

Otherwise, why would these stocks trade as if something needs to massively correct?

In other themes, we have:

Despite the continued supply disruptions out of the Middle East,

Distillate fuel spreads through Diesel cracks are coming down significantly.

As part of a broader growth shock theme developing, I expect this downward momentum to continue into the next quarter.

Which would have a direct positive impact on my long/short diesel spread trade.

That pairs trade is up significantly over the past month, upwards of 20% already!

Click here to see the mechanics behind that deal.

Now here’s the most important read we can get on the growth shock theme, especially through the pricing and supply side:

Whenever prices are this high, and new orders are this flat…

The Manufacturing PMI tends to fall by 5-10 index points over the next six months.

Given we are roughly three months into this theme, I would expect the introduction of fresh inventory to hit soon and begin that downward trajectory.

Again,

That would increase the attraction toward more defensive industries and stocks, where we are currently positioned and looking to add more exposure.

Now it’s time to cover which industries are worth looking into.

The ones that managed to escape the downward pull from this shift into a defensive stance.

Only three industries made the cut to justify a further drill into them:

In that order.

We will continue digging through these themes to make sure they are not flukes resulting from the “pull-forward” of orders ahead of further price hikes.

If that is the case, then there is going to be a lot of artificial upside noise in these industries.

Effectively invalidating our search within them.

On a scale of potential opportunities on the other end, we can find the following:

If bullish ideas fail to show themselves in the breakouts above, and the cyclical rollover is actually going to be the case moving forward…

Then these breakdowns could make for fantastic short opportunities in a long/short portfolio, this way we can eliminate some of the volatility running up to next month’s PMI print.

Notice the specific threats, however, inside the AI complex.

With electrical equipment and nonmetallic minerals (used in AI peripherals and optics) declining this month,

Chances are everything we’ve covered as far as spiking AI risks will begin to materialize in subsequent price action.

I will leave you with the above matrix of bullish/bearish industry picks to consider.

This understanding of the cyclical economy can also be used to understand why the S&P 500 is rotating this aggressively.

Especially why our picks have leaned on the defensive side of things now.

Coming up, after an additional view from the Services PMI, we’ll be able to come up with a watchlist of long/short ideas in these industry biases for Premium members.

Last month,

These ideas delivered over 30% returns combined…

Let’s do it again!

I believe one of the most lucrative areas to find opportunities here will be a mix of energy or memory shorts.

Especially as the spread between crude oil and distillates continue to close down and significantly compress refining margins.

For memory, my biggest thing is the aggressive injection of upcoming chip supply to do similar damage for margins there.

There are over 93,000 put options opened long for the energy ETF.

Their bet is that XLE will hit $60 or less by December 2026.

Which is awfully close to the catalysts found in the post midterm elections schedule for the U.S.

Again,

As refining margins continue to compress, and the growth shock of the economy begins to widen as well…

I do see a path lower for the energy complex from here.

Last time I gave you a signal in BLDR ahead of the wood products breakout, you made over 23% from that call.

Time to do it again.

Now $67.50.

Meanwhile, here is the latest from Jordi Visser (the retail AI voice leader at the moment) going back on his reiteration of the bull case.

As I’ve said before, his views were founded on more realistic concepts just as the AI trade was taking off earlier this year.

Now? He’s saying human time is changing, finances are not the same, and therefore company valuation meanings are out the window.

Accounting is not going to change as a universal truth, and neither will valuations in my view…

Until next time,

OFFSIDE RESEARCH

Against the Tape, Ahead of the Curve.