What to watch
Posted on 12 October 2015
“Courage is fear holding on a minute longer” George C Patton
Is that it? Are markets now ready to move on from some of the gloom that characterised the third quarter? We’ve argued for some time that the pessimism implicit in large parts of the world’s capital markets has looked inconsistent with incoming data on the world economy, which remains mixed far from disastrous for the moment. We still suspect the current economic cycle has further to travel. Jitters around China’s lumpy slowdown, US monetary policy and assorted other unknowns will surely return and we’ve long warned that we’re likely closer to the next US recession than the last. Of course, the consensus very rarely gets the timing right – many of those confidently predicting an imminent global recession in the last month are the same talking heads who have been doing the same for much of the last several years. This doesn’t mean these perennial doom-mongers can’t be right this time, but with important leading indicators pointing in the opposite direction, towards continued growth, we see clients still being best served by tilting diversified portfolios towards equities.
Aside from measures of so-called narrow money – M1, which have tended to be good lead indicators of turning points in the economy, indicators for the US, and wider consumption in developed economies (the prospects for which remain central to our more sanguine view of the prospects for global economic growth) have held up well so far. Nonetheless, in a world awash with data, central banker verbiage and assorted other talking heads, what else should we be keeping an eye on in these turbulent times?
Business confidence surveys or Purchasing Manager Indices (PMIs) for the manufacturing sector – These monthly surveys of a country’s manufacturing sector tend to be amongst the most reliable early warning signals, with the new orders component always of particular interest. Within this category, the US ISM manufacturing survey sticks out as the longest-running and therefore, most trustworthy. In Europe, the German Ifo survey has a similarly august record. There are certainly imposters within this category, pretenders that should be de-emphasised due to their youth, while even the older surveys are not infallible; however, they generally represent a decent lead indicator for the wider economy.
While the US ISM Manufacturing Index has been trending lower over recent months, the latest reading still sits at a level consistent with growth in the US manufacturing sector and economy. Historically, a reading above 43.1 tends to be consistent with continued growth, while past data has shown that it is not uncommon for the Index to dip below 50 even in non-recessionary periods. It will take a further meaningful decline before we start questioning the robustness of the US economy.
US employment data – Not only is employment a lagging indicator (they do not tell us anything new that the leading indicators do not tell us already), but the US non-farm payrolls data, which bring the financial world to a standstill on the first Friday of every month, is often subject to spectacular revisions in the ensuing months – neither particularly ideal qualities in an input into real-time investment decisions.
However, within the separate US employment report, changes in hourly wages are important at this stage of the economic cycle. The US economic recovery would be significantly harder to question with wages growing in the 3 – 4% range rather than the 2% seen at the last count. When precisely this perkier nominal wage growth picture will emerge is dependent on an assessment of the remaining slack left in the US labour market. Such an assessment is complicated by the dramatic fall in the labour participation ratio since 2007/08. How much of this declining participation rate represents workers permanently exiting the labour force is the key question. The level of wage growth suggests that slack remains, but we suspect ongoing job gains, even taking into account the slower pace of hiring seen in the last few months, will see wages rise a little more forcefully over coming quarters.
China related indicators – This week’s data on China’s foreign exchange reserves helped to settle a few nerves, though will remain closely watched for signs of accelerated capital flight over coming months. The IMF vote, due in November, on the Yuan’s eligibility to join its special drawing rights basket along with the Yen, US dollar, Sterling and the Euro will also be closely watched. Inclusion into this exclusive club will have positive demand implications for the Yuan by central banks and financial institutions worldwide, therefore having some potential to facilitate further monetary loosening by Chinese authorities.
William Hobbs, Head of Investment Strategy, Europe