On 1st October the US Institute of Supply Management Manufacturing data came out much worse than expected, causing a 2-day drop of 2.9%.
On 1st October the US Institute of Supply Management Manufacturing data came out much worse than expected, causing a 2-day drop of 2.9%.
On 1st October the US Institute of Supply Management Manufacturing data came out much worse than expected, causing a 2-day drop of 2.9%.
The figure grabbed financial news headlines, as the release of 47.8 was much worse than the 50.0 expected. Any number below 50 signals contraction in manufacturing.
It seems to be firmly entrenched in investors’ minds that the chances of a US recession over the next 12 months is a high probability event. The ISM release further confirmed these fears, lending evidence to the belief that the US economy cannot continue to grow on its own while the rest of the world is in a slowdown or even in outright recession.
Coupled with the yield curve inversion, investors have been raising cash or buying bonds. We have previously analysed the problems with using yield curve inversions to time investments; it simply doesn’t work in any reliable manner, despite inversions being called the most reliable indicators of a recession.
In assessing economic data for investors, they are often bunched into lagging (backward-looking) indicators and leading (forward-looking) indicators. Lagging indicators are often described as of limited use for investors. For example, GDP data determines whether an economy is in recession, but by the time we have seen two consecutive quarters of negative growth, equities are usually already in a bear market.
Leading indicators on the other hand, give an indication of what is to come. Rising retail sales, for example, are a leading indicator, as they directly increase GDP. Strong retail sales are also positive for companies, causing them to hire more people.
Manufacturing indices are a leading economic indicator (LEI), as lower manufacturing indicates a lower demand for inventory in the future, and thus potentially weaker customer demand. The negative equity market reaction to a contraction in this index therefore seemed justified. But not all lagging and leading indicators are of the same value.
Contrast this with what is normally considered a lagging indicator: interest rates. Central banks easing vs. tightening is an important factor for markets. When more than 50% of central banks are tightening, equities have historically struggled, losing -3% p.a. on average. On the other hand when more than 50% of central banks are easing, equities have achieved gains of more than 10% p.a.
Last year we had 60% of central banks in tightening mode, and equities struggled. After the Fed’s pivot earlier this year, and the many central banks that followed the Fed’s lead, the situation has completely reversed. Now more than 80% of central banks are in easing mode, which is historically a very bullish backdrop for equities.
When economic data grabs headlines, investors need to always look deeper to judge how useful that data has been for investors in the past. Many data points are worse than a coin toss for assessing the future direction of stock markets.
Investors need to continually update new economic releases into their models, which is complicated by the political nature that is aggravating the current slowdown. Aggregating current economic data points, they actually point to a bottoming of the current global weakness over the next two quarters, in sharp contrast to investors’ expectations of a looming global recession.
By LEONARDO DRAGO
Co-founder of AL Wealth Partners, an independent Singapore-based company providing investment and fund management services to endowments and family offices, and wealth-advisory services to accredited individual investors.
