Are equities "looking through" current economic weakness?

Posted on Thursday, February 14, 2019 at 09:28AM by Registered CommenterSimon Ward | CommentsPost a Comment

Global (i.e. G7 plus E7) six-month industrial output growth is estimated to have fallen to a 29-month low in December – only Canada has yet to release data. Industrial output momentum, suitably scaled, correlates closely with GDP growth, suggesting weakness in forthcoming data for the latter – see first chart.

The central scenario here, based on narrow money trends, is that industrial output momentum will decline further to a low around July, with little immediate recovery. Suppose that this timing proves correct and – though not currently signalled – global growth rebounds significantly in late 2019. Would such a prospect warrant a belief that global equities bottomed in December and have embarked on a sustainable upswing?

To address this issue, we examined the behaviour of global stocks around previous troughs in economic momentum. There have been 13 lows in G7 plus E7 six-month industrial output momentum since 2000, associated with downswings of varying severity. These troughs, and the associated prior lows in six-month real narrow money momentum, are highlighted in the second chart.

The red squares in the third chart, showing the MSCI World index, mark the dates of these economic momentum troughs. Nine of the 13 instances were associated with in an equity market reversal from weakness to sustained strength. In the other four cases, stocks fell after the low in industrial output momentum – so an economic turnaround later in 2019 is no guarantee of a resumption of a bull trend in equities.

In the nine cases where equities reflected the economic shift from slowdown to recovery, the market low occurred, on average, 2.4 months before the trough in output momentum – these lows are highlighted by the green crosses on the chart. The maximum market lead was six months, with one instance of a one-month lag.

On the basis of this experience, a July 2019 trough in industrial output momentum might be expected to be foreshadowed by an equity market low in April or May. A December 2018 bottom, implying a seven-month lead, would be outside the historical range.

Relatively long leads – of five and four months respectively – occurred in 2010 and 2012. Equities may have rallied early because of expectations of additional QE, confirmed by subsequent Fed announcements. The Fed has recently taken further rate rises off the table but QT is likely to continue at least through mid-year. An easing move is implausible barring renewed market declines and / or shockingly weak economic news.

The assessment here is that current economic conditions resemble those in late 2000 / early 2001. Global industrial output momentum reached a major low in June 2001, rebounding strongly in 2002. Equities rallied briefly ahead of this trough before plunging again, with an eventual low reached in October 2002. The reversal lower was influenced by the 911 terrorist attacks but, in addition, valuations were still unusually high in mid-2001 – fourth chart. Current valuations are less extreme, arguing against a similar prolonged divergence of economic and market trends.

Negative US monetary revisions

Posted on Friday, February 8, 2019 at 10:54AM by Registered CommenterSimon Ward | CommentsPost a Comment

The Fed yesterday released revised monetary data reflecting the annual benchmarking process and updated seasonal factors. Growth of narrow and broad money in 2018 was revised down significantly – see first and second charts.

The new data, in particular, show a smaller recovery and lower levels of six-month growth at end-2018.

The third chart shows the impact of the revision on global (i.e. G7 plus E7 ) six-month real narrow money growth*. The trough in the series still occurs in October 2018, suggesting a low in six-month industrial output momentum around July. On the previous data, however, growth had risen to a nine-month high in December. The new December reading is no higher than September's.

The new data, therefore, reinforce the negative assessment here of near-term US and global economic prospects while suggesting that weakness will extend into late 2019.

*M1A is used as the US component of this measure. The opportunity was also taken to revise the adjustment made to Indian M1 data to attempt to correct for the impact of demonetisation, with the distortion now assumed to have fully washed out by August 2018.

US loan officer survey signalling credit / economic weakness

Posted on Thursday, February 7, 2019 at 01:01PM by Registered CommenterSimon Ward | CommentsPost a Comment

The Fed's January senior loan officer survey provides further evidence of a deterioration in US economic prospects, signalling a tightening of loan supply and – more significantly – markedly weak credit demand.

The net percentage of banks tightening lending standards rose across all four major loan categories in the latest three months. An unweighted average of these balances turned positive, reaching the highest level since May 2017 – see first chart.

An average of the balances reporting stronger credit demand, meanwhile, moved deeper into negative territory, reflecting sharply weaker responses for residential mortgages and consumer loans – second chart.

The standards average rose above 20 before the last two recessions, while the demand average fell below -20. The standards measure remains well below the critical level but the demand measure now stands at -18 – third chart.

The January survey included special questions about banks’ outlook for 2019, assuming economic growth in line with the consensus. The responses suggest a further rise in the standards average to 11, with the demand average falling to -19. Banks are expecting additional demand weakness and tightening of standards for C&I and commercial real estate loans but a recovery in housing credit demand, probably reflecting the fall in mortgage rates at end-2018.

The current weakness of the credit demand average suggests that first-half GDP growth will undershoot the consensus forecast – fourth chart. A growth shortfall would probably result in a further ratcheting up of lending standards.

Credit demand indicators also weakened notably in the latest ECB and Bank of England lending surveys, discussed previously here and here.

Global money trends still downbeat

Posted on Tuesday, February 5, 2019 at 10:42AM by Registered CommenterSimon Ward | CommentsPost a Comment

Additional monetary data released last week confirm that global six-month real narrow money growth ticked higher in November / December. Growth, however, remains below its range over 2009-17 – a further sustained increase is needed to warrant a shift away from economic pessimism. January global manufacturing PMI results, meanwhile, are consistent with the forecast here of a joint downturn in the stockbuilding and business investment cycles.

Global (i.e. G7 plus E7) real money growth may have bottomed in October, suggesting that six-month industrial output momentum will slide further to a low around July, allowing for a typical nine-month lead.

Two-thirds of the recovery in global real money growth in November / December reflected a slowdown in inflation, due to weakness in oil and other commodity prices. Nominal money trends have yet to show much improvement – first chart.

The inflation boost could fade towards mid-year, assuming that commodity prices now stabilise – second chart. With economic weakness expected to intensify, however, a further decline in prices is plausible.

The uptick in global real money growth reflects G7 developments, with no revival in the E7 – third chart. The G7 rise has been driven by the US and, to a lesser extent, Euroland – fourth chart.

Stronger US money growth at year-end may prove temporary. Although the Fed capitulated last week, QT is likely to continue at least through mid-year, implying a further contraction in the monetary base (ignoring possible short-term volatility due to changes in the Treasury’s balance at the Fed) – fifth chart.

The expectation here remains that the current global economic downswing will be more severe than the slowdowns in 2011-12 and 2015-16. Global real money trends are weaker now, while cycle analysis suggests that business investment will exert a larger negative influence, adding to a drag from stockbuilding.

Global manufacturing PMI results are moving in line with the forecast. The new orders index fell below the 2016 low in January, with weakness led by investment goods demand – sixth chart.

The survey, meanwhile, confirms a downswing in the stockbuilding cycle: the annual change in the sum of the inventory indices for finished goods and purchased inputs turned significantly negative in January – seventh chart.

UK money trends: continued weakness

Posted on Thursday, January 31, 2019 at 10:41AM by Registered CommenterSimon Ward | CommentsPost a Comment

UK money trends, while not deteriorating further, continue to suggest a weak economic outlook. GDP growth may fall below 1% this year even if a no-deal Brexit is avoided.

Six-month growth rates of real narrow and broad money (non-financial M1 / M4) were little changed in December and remain low by historical and international standards – see first chart.

Real money growth, as in Euroland, has been supported by a fall in inflation. In addition, Brexit and other risks may have boosted the precautionary demand for money, in which case current money growth rates may overstate near-term prospects for spending on goods and services.

Consistent with the latter story, retail investors sold mutual funds in the fourth quarter of 2018 for the first time since the EU referendum quarter in 2016 (and on a larger scale than then)*. Bank of England commentary, meanwhile, notes an above-average rise in household M4 holdings in December, driven by deposits in interest-bearing instant access savings accounts. A savings measure combining M4 holdings, mutual funds, National Savings and foreign currency deposits (“non-financial M4++”) is growing more weakly than the money aggregates – second chart.

Broad money trends have been supported from the credit side by steady expansion of bank and building society lending to the private sector. The latest Bank of England credit conditions survey, however, suggests a coming lending slowdown – third chart.

The OECD’s UK composite leading indicator continues to give a gloomy message for economic prospects, falling further in December – fourth chart**. The indicator is designed to predict the direction of GDP relative to trend, i.e. a decline signals below-trend growth, with trend currently estimated at 2.0% per annum. Four of the six components exerted a negative influence in December – consumer confidence, local share prices, expected services demand and interest rates***.

The above developments argue for the Monetary Policy Committee to shift to an easing bias at its upcoming meeting, although such a move appears unlikely.

*Source: Investment Association.
**Estimate based on data for five of six components. OECD data released on 11 February.
 ***The other components are car sales and expected manufacturing output.

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