Download Investment Basics: Keeping Pace with the Global Leading Economic

Investment Basics:
Keeping Pace with the Global
Leading Economic Indicators
Economic indicators are figures and statistics about an economy. Economists and
analysts often refer to economic indicators when they present their analysis of the
economic performance and predictions of future performance of countries and/or
regions. But not all economic indicators are equally important. Leading economic
indicators, in particular, are indicators that usually signal an adjustment in the economy
before the economy as a whole changes. They are therefore especially useful as shortterm predictors of the economy. So which are the important ones you should take
note of as an investor? And what are they telling us now?
Over the past few months, we observed a positive flow of
economic data. They are not strong by any measure, but
certainly mark a break from the slew of disappointing readings
previously.
Global economic Indicators
Indeed, the Citi Economic Surprise Index, which measures
the extent that actual data beat the common view held by
analysts, has been consistently increasing, or as economists
like to use “trending up”. The implication of such a trend in
this kind of index is that the global economic outlook is not as
weak as previously thought.
Citi Economic Surprise Index
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Citi Economic Surprise Index
This is important as the careful analysis of the global economic
cycle analysis is a key part of our tactical asset allocation
framework. Research has shown that getting the calls on
macro-economic conditions right can be very profitable,
particularly at the turning points. For example, if stock
investors could have foreseen the last economic downturn
as early as December 2007, most would have avoided the
38.6 per cent drop in Dow Jones Industrial Average that
occurred in the next nine months after December 2007.
US Indicators
US Initial jobless claims
This metric measures the level of unemployment in the US. It
has been improving since last month, as it stayed below the
key 400,000 level. Claims of below that level suggest that the
job creation process is finally picking up steam, and helping
to mop up the excess labor in the market.
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Source: Bloomberg, 6 January 2012
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Why is this important? This is because more people at work
mean potentially more pocket money that gets spent in the
economy. Consumption spending accounts for up to 70
per cent of US gross domestic product (“GDP”). Indeed,
Geoffrey Moore, one of the pioneers in US business cycle
research, believed that the average weekly initial claims were
five months ahead of the economic cycle peak, and one
month ahead of trough. The steady improvement in labor
market conditions will hopefully set in motion a virtuous circle
of improved sales, higher corporate profits, and more jobs
created and increased consumption spending.
Initial Jobless Claims
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Jobless Claims
Four-week moving average
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Consumer Confidence
Aggregate spending is how much money is being “spent”
on a country’s economy. Spending by consumers is one of
the key contributors to the aggregate spending. Therefore,
it is important to monitor how consumers feel about their
economic prospects. In the US, there are two consumer
confidence surveys available. The first is the University of
Michigan Confidence Survey, while the second is from the
Conference Board.
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Both sets of numbers are holding up, despite the lackluster
economic data in the US, and negative pressures (also
termed “overhang”) from problems in Europe. However, that
could change rapidly if the situation deteriorates rapidly.
Source: Bloomberg, 6 January 2012
Michigan Confidence Survey
Our analysis shows that the ISM new orders net of inventory
reading is a good nine-month leading indicator for US GDP
growth. The latest reading marks a reversal from the decline
seen in previous months. Assuming that the metric continues
to lead the economic growth by about nine months, we may
see a respectable bounce from a cyclical weakness in the
first half of 2012.
ISM new orders minus inventory
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ISM new orders minus inventory
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Michigan Confidence Survey
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US ISM new orders minus Inventory
As anyone who has worked in manufacturing will tell you, new
orders are the lifelines of factories. New orders generate sales
and profits, but this has to be offset by existing inventories.
As it is, factory producers will typically meet new orders by
first drawing down on existing stocks. Only when stock levels
have run low, will manufacturers tap the production lines to
supply new products.
Source: Bloomberg, 6 January 2012
the rest of the world
Elsewhere in other countries, there’s also a number of forward
looking indicators that are worth tracking.
The top of the list of is the purchasing managers’ index
(“PMIs”) for various countries. This is the equivalent for the
ISM index for the US, and it is a health barometer for the
manufacturing sector. Although services sector continues to
dominate in terms of share of GDP for many countries, bulk
of the swings in economic growth has come from factory
production. Therefore, it is important to track this indicator.
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Source: Bloomberg, 6 January 2012
Apr 02
Jul 03
Oct 04
Jan 06
Apr 07
Jul 08
Oct 09
Jan 11
Apr 92
Jul 93
Oct 94
Jan 96
Apr 97
Jul 98
Oct 99
Jan 01
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Oct 89
Jan 91
Jan 71
Apr 72
Jul 73
-20
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-10
Latest PMIs reading from Germany, France and China show
a significant slowdown in industrial activity in recent months.
In the case of France, the index pointed to contraction mode
(one below 50 marks contraction), and bodes ill for the Euro
zone member.
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IFO Business Confidence
China PMI
Jun 10
Feb 11
Oct 11
Jun 08
Feb 09
Oct 09
Jun 06
Feb 07
Oct 07
Jun 04
Feb 05
Oct 05
Jun 02
Feb 03
Oct 03
Jun 00
Feb 01
Oct 01
Jun 96
Feb 97
Oct 97
Jun 94
Feb 95
Oct 95
Jun 92
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Oct 93
Jun 98
Feb 99
Oct 99
IFO Business Confidence
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Feb 91
Oct 91
China’s official PMI has shown a brief rebound, even though
the index has been trending down for the past few months.
Given the concerns over the asset price bubble in its property
market, there’s a risk that China’s economy may end up in a
hard landing scenario owing to the spillover effects on the
banking sector.
Source: Bloomberg, 6 January 2012
China PMI
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Conclusion
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Source: Bloomberg, 6 January 2012
Confidence survey
In Germany, the PMI has held up above 50, even though the
signs of slowdown are definitely evident. Part of this could
be weaker demand from the rest of Europe, as confidence
across the continent broadly weakened.
Within Germany, however, in addition to looking at the PMI,
investors should also look at Germany’s IFO survey which
is an indicator of business confidence. For now, it seems
to indicate that sentiments are keeping steady. Although
business confidence has come off quite a bit, recent data
points suggest that there may be a turnaround.
In summary, it is important to track leading economic indicators
as they serve as torches that shine on the investment outlook
ahead. Examples of such include labor market data (jobless
claims), manufacturing orders and confidence readings.
In the US, the world’s largest economy, the indices broadly
point to a muddling through of the economy despite the
risk of headwinds from Europe. Our view is that the country
should be able to stay clear of downturn, assuming that the
troubles in Europe do not spillover across the Atlantic.
In China, while outlook has grown more subdued, due in part
to the monetary tightening seen earlier, we believe that the
country’s investment and development story should remain
intact in the medium term. Therefore, a soft landing scenario
is more likely to occur than a hard landing one. The leading
indicators such as the PMI bear that up, as those metrics
have recovered from the cyclical weakness seen previously.
In Europe, the leading indicators are pointing to a possible
recession as the PMIs of France and Germany continue to
stay below 50. Across the rest of the European continent,
the PMI is now below 50, suggesting that the manufacturing
sector will continue to shrink.
The leading indicators are able to give a picture of which part
of the world is performing better in the current uncertain times.
However, in view of the macro uncertainty, we recommend
that investors take a cautious investment stance for the first
quarter of 2012.
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