ISM and SP500

The last years, after 1998 and especially 2007, the S&P500 rose (and declined) often in line with the ISM. On a yearly base the correlation is high. Deutsche Bank’s Jim Reid and Stephen Stakhiv concluded from the relation between the ISM and the S&P (I took their idea via FT Alphaville and made the charts above) that the S&P is still somewhat undervalued (and in this case that means it offers some hope you can profit from an undervaluation).

For timing for selling equities the indicator was sometimes a disaster: you became optimistic in 2008. For the timing of buying equities it looks somewhat better. At the end of 2002/start 2003, in 2009 and at the end of 2011 you saw equities were way to cheap. Since 2009 it is doing pretty well (no guarantee for the future).
It is clear you mainly can profit when you can forecast the ISM well, then you have some clues where the S&P will go. Especially when you see the ISM dive below 48 for some protracted period you can better say goodbye to equities, but when you see that the ISM will recover distinctively that is a powerful signal to buy equities (when your forecasts are really good).

Unfortunately it is very hard to forecast the ISM (the efficient market forces this: you can earn too much money from forecasting well the ISM, so there is arbitrage to the best ISM consensus models that are hard to beat)
It is not always impossible to forecast the ISM. After 2008 the ISM followed pretty well the average of the preceding seven recessions (as I blogged on the sister blog Beleggen op de golven until the end of 2011). Now we are too far in the cycle and I have another forecasting model. That is doing a reasonable job, but is far from perfect.