Investors are concerned about weakness in the global economy and China in particular. Monetary trends are giving a reassuring message, suggesting that economic growth will revive into early 2016 before slowing again later next year.
The monetary measure used for forecasting here is the six-month change in global real narrow money, with “global” defined as the G7 plus seven large emerging economies (the “E7”)*. Statistical testing shows that this leads the six-month change in industrial output by nine months on average. Turning points in industrial output growth, meanwhile, usually coincide with those in GDP growth.
The six-month change in real narrow money turned negative before the six global recessions since the 1960s.
Real narrow money growth has moderated from a peak in February but rose slightly in August and remains solid by historical standards – see first chart. Its strength in early 2015 suggests that global activity news will improve near term but the uplift in growth may prove temporary, based on the more recent monetary slowdown.
Real broad money is giving a similar message to narrow money, though has an inferior historical record as a forecasting indicator of the economy.
The six-month change in industrial output appears to have remained negative in August, based on available data, but may have bottomed in June – first chart. If the monetary forecast is correct, it should soon return to positive territory.
Real narrow money is very far from contracting, suggesting a low risk of a recession. However, the low level of interest rates may be boosting the “trend” growth rate of narrow money, implying that a significant slowdown would be a sufficient signal for a recession. To attempt to gauge this possibility, a forecasting indicator was constructed allowing for divergent trends of real narrow money and industrial output growth, and also applying the average nine-month lead. A second indicator was calculated additionally incorporating the slope of the G7 yield curve, which – like real narrow money – has a good record of signalling recessions. These adjusted real money growth indicators are giving a reassuring message – second chart.
The relative stability of global real narrow money growth conceals some significant changes at the country level. As discussed in a previous post, real narrow money has slowed sharply in the US over the last six months while rebounding strongly in China. These and other changes have resulted in E7 growth moving above the G7 level for the first time since June 2013 – third chart.
Is this a positive signal for emerging market equities? As noted in another recent post, a “simplistic strategy that would have worked well would have been to invest in emerging markets when E7 six-month real money growth was above 4% and had not fallen by more than 2 percentage points over the prior six months but revert to developed markets if either of these conditions was no longer met”. August E7 growth was an estimated 3.0%**.
*The G7 only was used in analysis before 2005. Narrow money = currency in circulation plus demand deposits and close substitutes; precise definition varies by country. Real = deflated by consumer prices, seasonally adjusted. “E7” defined here as BRIC plus Korea, Mexico and Taiwan.
**August data available for all countries except Korea.
