The approach to forecasting the global economic cycle employed here places emphasis on two variables – the global real (narrow) money supply and a leading indicator derived by combining and transforming the OECD’s country leading indices.

Historically, global real money has led turning points in industrial output by about six months versus about three months for the OECD-based indicator.

The chart below shows the six-month rates of change of global (i.e. G7 plus emerging “E7”) output and real narrow money. Real money led at each of the four output momentum turning points since 2008, with no false signals. The lead times ranged from six to nine months, averaging 7.75.

The next chart superimposes the OECD-based leading indicator, which has a similarly good record with lead times of between two and five months, averaging 3.25.

A powerful signal is generated when the two indicators confirm a shift in direction, as they did positively in early 2009 and negatively in early 2011 (allowing for data reporting lags). Such signals have foreshadowed big changes in consensus expectations about the cycle and associated swings in risk assets.

The six-month change in real money remained positive during the latest downswing and has been moving up since May 2011. The OECD-based indicator, however, continued to fall through July – second chart. The Eurozone financial crisis, moreover, threatened to abort the upswing in the money measure, resulting in another “double negative” signal.

Thankfully, the latest data – for August – show a further recovery in global real money growth and a leveling off the OECD-based indicator, though at a very weak level. This stabilisation – if confirmed – is slightly ahead of schedule based on the bottoming out of real money expansion in May and an average lead of real money on the indicator of 4.5 months at the last four turning points.

September OECD leading index data, to be released in early November, therefore, will be key. A rise in the composite indicator from August would confirm the message from real money growth, giving a “double positive” signal – the last such signal occurred in August 2010 as the “QE2” rally was gathering steam.

With a possibility of further negative financial developments in the Eurozone, investors should await the data. The chart below shows that the OECD-based leading indicator usually turns before equities – the average lead on the six-month change in prices has been 2.25 months at the last four turning points. Confirmation of an August bottom in the indicator, therefore, would imply a recovery in equity market momentum from October or November.

Any hint of a bottoming and upturn in the global economic cycle could have an outsized positive impact on risk assets given depressed investor sentiment and an ongoing injection of liquidity by central banks. As shown below, aggregate bank reserves at the major central banks have risen by about $500 billion since equities topped in the spring, with UK QE2 scheduled to deliver a further $115 billion boost.