Returning from a long hiatus. There were some network connectivity issues that were recently resolved. As usual I welcome feedbacks and comments.
Goldman has its own leading economic indicator (GLI). Let’s never mind for the moment whether these guys are right or not – we all know often these are wrong. But it could be a data point in “triangulating” a view when multiple indicators start pointing in the same direction.
ECRI – a pretty well respected third party economic researcher – recently showed a very sharp reversal in its leading indicator. Goldman had been a HUGE bull so reversal here is notable:
• While the peak in the headline reading was clearly in March, the headline remains at a very high level. But monthly momentum has also fallen further, to 0.19%mom from last month’s revised 0.23%mom, but remains consistent with continued moderate growth in the industrial cycle.
• We have highlighted for some time now that the GLI is pointing to some slowing in industrial momentum, although from extremely high levels, a message that our improved GLI shows more clearly.
• In any recovery, the acceleration phase inevitable ends and our forecasts show some slowing in growth into 2010H2, though to healthy levels. Although our US forecast is still firmly below consensus, our global forecast does not envisage a sharp slowdown. That said, it will be critical to watch whether the current slowdown in momentum remains moderate in the months to come.
Now – if we buy into the validity of their leading index, how do the assets perform when the GLI is in decline?
No surprise equities underperform, bonds outperform, vol rises and credit spreads widen. Among equities cyclical and EM underperform particularly so.
Commodities as a group underperforms with the impact most severely felt at industrial metals and precious metals least affected.
In FX arena, the impact is less clear. GBP, SEK and NOK appears to be more “cyclical” than the others and CHF the least cyclical.
I definitely agree that deceleration is only natural and we are by no means in a dire straits. What concerns me though are withdrawal of stimulus and continuing weakness in consumption.
On the other hand, Morgan Stanley lays down a firmer view that current skepticism is way overblown. That this market looks exactly like 1998:
• The recent performance of both equities and bonds is worrying; however, we continue to believe that we are currently witnessing a stock market event rather than a real economic event. Our economists are confident that the global economy will not double-dip and we agree with them. In short, we think this is more like 1998 (when an EM-led sovereign debt crisis and LTCM-inspired financial crisis caused a huge growth scare) than 2008. If we are right in this assumption, then Exhibits 1-3 suggest that both equities and bond yields can fall further in the short term before rebounding strongly thereafter. Timing short-term moves in these markets is tricky at best; however we do expect equities to be meaningfully higher by year-end.
My points of disagreement with MS are following:
1. Always dangerous to just look at charts and say – this looks like what happened before so maybe the future unfolds just like this.
2. Back in 1998 unemployment was at 4.5% - it’s 10% today.
3. Back in 1998 Fed Funds rate was at 5.5% and it was immediately lowered to 4.75% as the LTCM crisis unfolded. There is no room to play with interest rate at this point.
So basically I dont buy into the argument that today’s anything like 1998.
On another note, Goldman says that investors are becoming increasingly bearish:
• Clients are uniformly bearish, led by the macro community. Deflation now ranks much higher as an investor concern than inflation, which until just a week ago was still viewed as the greater risk. Concerns articulated by various investors included the prospect of a relapse in US housing; weak job formation leading to further slowdown in consumer spending; and legislative and regulatory uncertainty that eroded CEO confidence and curbed capital spending plans. Ten-year Treasury yields slipped below 3% and 5-year implied inflation currently equals just 0.25%.
That “uniformly bearish” part concerns me (myself being in the bear camp) because that many people are usually not correct in calling market turns.
Looking ahead I see further deceleration in economic momentum – which is not necessarily an abnormal or a bad news. How the markets would respond to such news is the key. I still believe double-dip recession is unlikely in 2010, but until that prospect becomes clear (probably another couples month for the stabilizing pattern to show in data) risk is to the downside.
I would advocate taking some exposure off on a short term rally. Perhaps the stock market heads higher going into the earnings season and sells off once it begins.
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