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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 150 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. 100 50 0 -50 -100 Source: Bloomberg, 6 January 2012 06 FUND FOCUS | FIRST HALF 2012 Investment Basics De c 11 11 11 ct O Au g 1 11 n Ju 11 r1 Ap 10 Fe b De c 10 10 g ct O Au 0 10 r1 n Ap Ju 09 10 b De c Fe 09 09 ct O Au g 9 09 n Ju r0 Ap Fe b 09 -150 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 700 650 Jobless Claims Four-week moving average 600 550 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. 500 450 400 350 300 250 /1 1 /1 0 /0 7 01 /0 9 /0 7 01 /0 8 /0 7 01 /0 7 /0 7 01 /0 6 /0 7 /0 5 /0 7 01 01 /0 4 /0 7 /0 7 01 01 /0 3 /0 2 /0 7 01 /0 1 /0 7 01 /0 7 01 01 /0 7 /0 0 200 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 40 ISM new orders minus inventory 30 120 Michigan Confidence Survey 110 100 90 80 70 60 50 Feb 78 Feb 79 Feb 80 Feb 81 Feb 82 Feb 83 Feb 84 Feb 85 Feb 86 Feb 87 Feb 88 Feb 89 Feb 90 Feb 91 Feb 92 Feb 93 Feb 94 Feb 95 Feb 96 Feb 97 Feb 98 Feb 99 Feb 00 Feb 01 Feb 02 Feb 03 Feb 04 Feb 05 Feb 06 Feb 07 Feb 08 Feb 09 Feb 10 Feb 11 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. 20 10 0 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 Jul 83 Oct 84 Jan 86 Apr 87 Jul 88 Oct 89 Jan 91 Jan 71 Apr 72 Jul 73 -20 Oct 74 Jan 76 Apr 77 Jul 78 Oct 79 Jan 81 Apr 82 -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. FIRST HALF 2012 | FUND FOCUS Investment Basics 07 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 Feb 93 Oct 93 Jun 98 Feb 99 Oct 99 IFO Business Confidence 120 115 110 105 95 90 85 80 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 65 60 55 Conclusion 50 45 40 Aug 11 Nov 11 Feb 11 May 11 Aug 10 Nov 10 Feb 10 May 10 Aug 09 Nov 09 Feb 09 May 09 Aug 08 Nov 08 Feb 08 May 08 Aug 07 Nov 07 Feb 07 May 07 Aug 06 Nov 06 Feb 06 May 06 Aug 05 Nov 05 Feb 05 May 05 35 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. 08 FUND FOCUS | FIRST HALF 2012 Investment Basics