Global momentum bottoming, not turning: investment thoughts

Posted on Tuesday, September 10, 2019 at 02:16PM by Registered CommenterSimon Ward | CommentsPost a Comment

August PMI results are consistent with the long-standing expectation here that global industrial momentum would bottom around Q3 2019 but narrow money trends have yet to signal an economic recovery. Turning points in industrial momentum are usually associated with a rotation in financial markets but the still-weak economic outlook suggests that any such change will be muted or delayed.

Global manufacturing PMI new orders were little changed for a second month in August, while order backlogs reversed a July fall – see first chart. The new orders-inventories differential – regarded as a leading indicator – dropped back but remains above a March low. These developments hint at a stabilisation of industrial momentum following an 18-month slide.

The view that momentum would reach a trough around Q3 was based partly on the stockbuilding cycle, which has an average duration of 3 1/3 years and last bottomed in H1 2016. The cycle is illustrated by the second chart, showing the contribution of stockbuilding to the annual change in G7 GDP. This was still positive in Q2, suggesting that the cycle downswing could last for several more quarters before reaching a trough.

Business surveys, however, are signalling a major inventories downdraft during H2 – the third chart shows a survey-based measure that correlates with and sometimes leads the GDP stockbuilding data. This indicator has fallen to levels consistent with a cycle low, which may be confirmed – after the event – by the GDP data for Q3 / Q4.

The reasons for doubting that a low in industrial momentum associated with a trough in the stockbuilding cycle will be followed by an economic recovery are 1) global real narrow money growth remains weak and 2) the business investment cycle remains in a downswing and may not bottom until H1 2020.

On 1), global six-month real narrow money growth fell back in July and early indications for August are disappointing – US weekly numbers have been weak and global six-month consumer price inflation appears to have remained elevated.

On 2), a trough in the investment cycle is usually marked by the annual change in G7 business investment turning significantly negative and undershooting the annual change in real operating profits, which recovers first. Based on Q2 data, these conditions may not be met for several more quarters – fourth chart.

Financial market trends typically reverse around stockbuilding cycle troughs. The table shows that the pattern of returns during the current cycle downswing – assuming a Q3 trough – has been similar to an average of seven previous cycles. In particular, US equities and quality stocks have outperformed, emerging markets have been under pressure, the US dollar has strengthened and Treasury yields have fallen.

A view that the stockbuilding cycle is bottoming would normally imply that investors should rotate portfolios in favour of international / EM equities, value stocks, foreign currencies, commodities and credit, while reducing exposure to defensive US / quality equities and “safe” bonds. With an economic recovery likely to be delayed, however, such a shift could be premature.

Global equities, unusually, have risen during the current stockbuilding cycle downswing – an additional reason for thinking that defensive trends in markets may be incomplete.

A possible approach is to adjust exposure to areas that have already out- or underperformed by more than average for stockbuilding cycle downswings while retaining an overall cautious strategy. This would suggest, for example, reducing US / quality in favour of EM and value equities while retaining an underweight in cyclical sectors.

There is also a case for focusing a portfolio shift in countries / regions, such as Euroland, where money growth has picked up convincingly, implying an earlier economic recovery.

OECD leading indicator preview: further weakness

Posted on Thursday, September 5, 2019 at 12:15PM by Registered CommenterSimon Ward | Comments2 Comments

The OECD’s G7 leading indicator is estimated to have fallen further in July, although the six-month rate of change remains above a February / March low. These developments are consistent with the forecast here that global industrial momentum is bottoming in Q3 but will remain weak into early 2020.

The OECD will release July data for its leading indicators on Monday but information is available for most of the components, allowing an independent calculation. The indicators are presented in ratio-to-trend form, so a fall signals below-trend economic expansion (or worse). The G7 leading indicator posted another large decline in July, with the recovery in the six-month rate of change stalling – see first chart.

The indicators are widely monitored and the downbeat July reading may be interpreted as confirming an apparent recession signal from inverted yield curves. There is, however, a danger of double-counting, since the OECD indicators for the US, Japan, Germany and Canada include the long yield / short rate spread as a component.

To investigate this issue, a modified version of the G7 indicator was calculated incorporating measures for the above countries excluding yield curve components. As the second chart shows, the modified indicator is only slightly less weak than the official version, i.e. the other components are giving a similar message to the yield curve.

The forecast that global industrial momentum will remain weak reflects a so-far modest recovery in global six-month real narrow money growth from a Q4 2018 low. Real money growth fell in July, although the final reading was above a preliminary estimate discussed in a previous post, mainly reflecting Euroland strength – third and fourth charts. The July setback reflected Chinese weakness; August data will be important for assessing whether this was “noise” or – more likely – signals a need for more significant monetary policy easing.

UK data wrap: more recessionary indications

Posted on Friday, August 30, 2019 at 03:04PM by Registered CommenterSimon Ward | CommentsPost a Comment

UK economic news remains consistent with a recession having started in Q2.

The CBI’s expected growth indicator – a GDP-weighted average of future output or sales responses from its monthly surveys of manufacturing, distribution and other service industries – is estimated to have plunged into contraction territory in August; the CBI will release the August result over the weekend – see first chart.

An early recession warning was a contraction of real M1 holdings of private non-financial corporations (PNFCs) in the six months to February, signalling likely business retrenchment. July monetary data released today show that the six-month change remained negative last month – second chart.

Household real M1 holdings are still growing but have slowed, with further weakness likely as a softer labour market curbs income growth. Households were markedly more pessimistic about recent and prospective trends in their finances in the August GfK / EU Commission consumer survey, contributing to a large drop in the composite confidence index – third chart.

Euroland money trends suggesting 2020 recovery

Posted on Wednesday, August 28, 2019 at 12:39PM by Registered CommenterSimon Ward | CommentsPost a Comment

Euroland money measures grew strongly in July, more than compensating for softer June data and suggesting improving economic prospects.

Previous posts argued that economic momentum would bottom around Q3 and recover into 2020, based on a strong rise in six-month real narrow money growth between November 2018 and March 2019. The monetary pick-up stalled in Q2 but is now back on track, while the manufacturing PMI appears to be stabilising on schedule – see first chart.

Six-month growth of nominal narrow money rose to a 25-month high in July – second chart. The Q2 pull-back in real money expansion reflected a rise in six-month consumer price inflation but this is probably peaking.

Narrow money acceleration is being driven by plunging bond yields, which have moved to discount a major ECB easing package next month. Euroland monetary and economic trends are sensitive to changes in longer-term yields – third chart.

A country breakdown is available for the deposit component of narrow money. Growth is solid across the big four but has cooled recently in Spain while strengthening in Italy – fourth chart.

While monetary trends are hopeful, the economic outlook remains at risk from hostile external policies – a no-deal Brexit and / or US imposition of auto tariffs.

Industrial output has fallen by more in Germany than other Euroland economies, partly reflecting greater sensitivity to Chinese / global trends, but a bounce-back could be imminent. Recent woes were signalled by the six-month change in real M1 deposits of non-financial corporations turning negative in late 2018 but the latter weakness has now reversed – fifth chart.

The August Ifo manufacturing survey, meanwhile, contained glimmers of hope, with the orders inflow balance improving and the finished goods stocks balance consistent with a bottom in the inventory cycle – sixth chart.

Global economic weakness due to monetary policy not trade wars

Posted on Tuesday, August 27, 2019 at 03:31PM by Registered CommenterSimon Ward | Comments1 Comment

The preferred narrative of central bankers and mainstream economists is that current global economic weakness primarily reflects US-driven trade policy conflict, which has depressed business confidence and derailed expansion plans. This narrative is false.

The loss of economic momentum started in H1 2018 and followed a collapse in global six-month real narrow money expansion during H2 2017. This collapse was caused by Chinese and US monetary policy tightening: the Fed had raised rates by 100 bp by June 2017, while the PBoC’s liquidity squeeze on shadow banking had inverted the Chinese government yield curve (i.e. 10-year versus 2-year).

The Trump administration began to impose tariffs only after the monetary shock, with the increase in coverage from $50 billion to $250 billion of Chinese imports proposed in H2 2018, by which time the global economy was already slowing sharply – see chart.

The trade conflict may have contributed to monetary weakness more recently, by suppressing spending plans and associated money demand. A more likely explanation, however, for money growth remaining low is the lagged impact of the further – and excessive – rise in US rates during H2 2017 and 2018.

Other central banks followed the Fed’s mistake of raising rates into monetary weakness, with the UK MPC an egregious offender.

The trade conflict provides a convenient excuse for such actors, enabling them to deflect blame for their policy errors. Mainstream economists are in collusion because of their own failure to forecast economic weakness.

Monetary policies are now easing but moves to date may be insufficient to offset previous excessive tightening and negative trade policy effects. This is suggested by weak July money numbers: as previously discussed, global real narrow money growth appears to have fallen sharply – additional July data this week will provide clarification.