A post last week argued that the current mini-upswing in global growth would peak this spring, based on a slowdown in real narrow money since late 2011. Such a scenario should be flagged by a topping out of widely-watched manufacturing purchasing managers’ survey indices – the forward-looking new orders component in particular.
A peak in the US ISM manufacturing new orders index within the next couple of months is suggested by recent falls in three-month retail sales volume growth and the expected orders balance in the Philadelphia Fed regional manufacturing survey. Both measures tend to lead ISM new orders, as the following charts show.
The prospect of less upbeat global economic news from the spring may warrant investors trimming overweight positions in equities and other risk assets. It may, however, be premature to move underweight, for several reasons.
First, equities have tended, if anything, to lag the economic cycle in recent years. The March 2009 US stock market low, for example, followed a December 2008 bottom in ISM manufacturing new orders. The July / August 2011 sell-off, similarly, occurred after a May plunge in the ISM. On this basis, a March 2012 peak in new orders could be consistent with equities remaining firm until May / June.
Secondly, while investors have embraced risk recently, available evidence does not suggest that positions are extreme. Fund manager cash levels are normal rather than low, according to the February Merrill Lynch survey. The Credit Suisse risk appetite measure, similarly, is far below the “euphoria” region that often marks cycle tops.
Thirdly, global liquidity conditions remain favourable, with G7 real narrow money outpacing industrial output and central banks continuing to inject liquidity – the second ECB three-year LTRO coupled with stepped-up JGB purchases by the Bank of Japan may lift G7 bank reserves above their late 2011 high. The mid-2011 economic cycle peak, by contrast, occurred when the G7 real narrow money / industrial output growth gap was negative and US QE2 was ending, possibly explaining the severity of the subsequent risk sell-off.
Finally, markets may “look through” a modest weakening of economic indicators on the view that this would give a trigger-happy Fed an excuse to launch QE3. True, US “core” inflation is proving uncomfortably resilient – see below – but modern central bankers routinely ride roughshod over facts in pursuit of ideologically-driven policy prescriptions, as recent UK experience amply demonstrates.
