Six-month growth in global* industrial output is estimated here to have reached a 20-month high in October – see first chart. The recent pick-up was predicted by strong expansion of real narrow money in the second half of 2012 and first half of 2013. Solid November manufacturing purchasing managers’ surveys suggest that growth quickened further last month.

Six-month real narrow money expansion, however, has moderated from a peak in May. Its excess over industrial growth, therefore, has narrowed to its smallest since spring 2012, when equity markets last weakened significantly**. The gap between real broad money expansion and output growth is now negative. The liquidity backdrop for markets, in other words, has deteriorated.

Recent real money trends suggest that economic growth is at or close to a peak but will remain respectable in early 2014. A return to a significantly positive real money / output growth gap, accordingly, seems unlikely, barring further central bank monetary stimulus. A rising gap due to economic weakness, in any case, would not be bullish for equities in the short run.

Improving labour markets and stable inflation argue against further policy stimulus. Six-month global* consumer price momentum has firmed slightly since early 2013 and commodity prices are not signalling increased deflation risk – second chart. Recent lower-than-expected inflation in the Eurozone partly reflects currency strength and is balanced by a big rise in Japan.

Optimists argue that corporate earnings expansion can drive equities higher as long as central banks do not tighten policies abruptly. They may underestimate a liquidity withdrawal that is occurring automatically as economic activity strengthens. The key bullish risk to the cautious view here is that the Federal Reserve will offset an early decision to taper QE by cutting the interest rate on bank reserves, prompting parallel reductions by the ECB (to negative) and Bank of England. Such action seems unlikely while growth remains solid.

*G7 plus emerging E7.
**The MSCI World Index fell by 13% in US dollar terms between 19 March and 4 June 2012.