Forecasting indicators suggest slow growth, not recession
NS Partners
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The global economy is weak but not recessionary. GDP in the G7 developed economies and seven large emerging economies (the “E7”) rose by 1.1% between the second and fourth quarters of 2015, equivalent to an annualised rate of 2.1%*. The latter compares with average growth of 2.9% per annum (pa) since 1997 but is no weaker than in the same period of 2012 – see first chart.
The forecasting approach here views economic fluctuations as reflecting the interaction of three distinct cycles – the 3-5 year Kitchin inventory cycle, the 7-11 year Juglar business investment cycle and the 15-25 year Kuznets housebuilding cycle. The 2012 and current slowdowns are judged to be partly due to downswings in the Kitchin cycle. US inventories remain high relative to sales, suggesting that the downswing in this cycle has further to run.
Recessions usually occur when two or more cycles weaken simultaneously. The Kuznets housebuilding cycle bottomed in 2009 and will remain in an upswing for many more years. The Juglar business investment cycle also bottomed in 2009 and is scheduled to reach another low between 2016 and 2020. If the Juglar cycle turns down before the current Kitchin downswing has bottomed, a recession is likely. This is possible but is not the central scenario here, reflecting a judgement that corporate finances are not yet sufficiently pressured to trigger a major investment cut-back.
Fluctuations in global industrial output closely track those in GDP but with a “beta” of about 3. That is, industrial output rises at a similar rate to GDP when the latter is growing at trend, but each 1 percentage point (pp) shortfall in GDP growth is associated with an undershoot in industrial output expansion of about 3 pp. G7 plus E7 GDP growth is currently about 1 pp below trend, implying that industrial output should be roughly flat (i.e. trend growth of about 3% pa minus a 3 pp undershoot). It is: output rose by 0.2% in the six months to January – first chart.
Near-term economic prospects are best assessed by monitoring monetary trends and leading indicators. The second chart shows changes in G7 plus E7 industrial output and a composite leading indicator calculated from the OECD’s country leading indices. The leading indicator suggests that output prospects remain weak but are not deteriorating further. The latest monthly change in the indicator is marginally positive, though could be revised.
Monetary trends are giving a more hopeful message, though failed to signal the extent of recent economic weakness – third chart. Six-month growth of G7 plus E7 real narrow money – the preferred measure for forecasting purposes here – has recovered from a minor low in August 2015. Allowing for a typical nine-month lead, this suggests a recovery in industrial output momentum from May. Confirmation that the leading indicator has bottomed would increase confidence in such a scenario.
*Weighted average of country data, with country weights equal to an average of current US dollar and purchasing power parity GDP shares.
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