investment viewpoints
Do markets disagree with the economic data?
Equity markets continue their impressive breakout, setting all-time highs and showing steady gains. However, this is triggering concerns over what’s driving the rally and whether it can continue. As the saying goes: ‘sell in May and go away’.
This week, Simply put explores the implications of a discrepancy between current market optimism and the recent macro data.
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Nowcasting growth
The real driver of the nearly unprecedented surge in markets – besides receding inflation and the change in monetary policy – is growth. Markets gained since the start of the year essentially because of a better-than-anticipated macro backdrop. That at least is the current consensus in the industry. We do not like consensus or impressions and prefer to build our own measuring tools, such as our nowcasting signals.
The task here is simple: use market data to nowcast the growth regime, in an attempt to gauge the risk of an economic downturn in the eyes of markets. The obvious next question is: do markets agree with our growth nowcasting signals? Not quite, and here is how.
Can markets nowcast?
Significant events, e.g., economic downturns, policy changes or other market-shifting occurrences, can experience reporting delays, and here is where nowcasting comes in. This technique combining ‘now’ and ‘forecasting’ was originally developed for weather modeling, but has been adapted for macroeconomics. The nowcasters we have developed examine, in a point-in-time manner, three key economic cycles: growth, which captures recessions and expansions; inflation surprises; and monetary policy surprises, which capture the hawkishness and dovishness of central banks. These indicators play a crucial role in investment decisions as financial assets rely on future cash flows that are discounted to their present value.
Nowcasters are based on information from past regimes, combined with macroeconomic time series that are subject to being governed by a current, and therefore unobservable, regime. These aggregated indicators have been obtained from testing for the nowcasting capacity of a large number of economic time series and retaining those that proved historically reliable. At the bottom of this column, our regular readers can find the latest evolutions of our nowcasting signals. These few charts suggest that growth seems to be recovering and disinflation remains present, while central banks increasingly show signs of pivoting.
Now the question is, can we use market information to nowcast growth regimes? If so, we could gauge market sentiment on recent macro data and the extent of their agreement. We created such an indicator, converting trailing returns into a growth regime measure. Figure 1 shows the output from our computations, as obtained from a dataset of market indices from four assets classes: equities, fixed income, commodities and currencies.
The chart shows an essential conclusion. Our growth nowcaster is currently on an upward trend, but volatile. The curve started to rise at the end of 2023, as inflation continued to release stabilising numbers and the Federal Reserve announced its pivot. When it comes to markets, that growth signal is clearly higher, showing a stronger surge since September 2023. Diving deeper into the analysis and breaking it down to each market provides an even clearer picture.
FIG 1. Market vs. macro nowcasters for growth (1990 – 2024)
Source: Bloomberg, LOIM. As at March 2024. For illustrative purposes only.
Looking under the hood
In Figure 1, the market nowcaster indicates two extra lulls compared with the macro one. These correspond to the emerging market crisis in 1998 and the China slowdown from 2015. Both nowcasters began rising at the end of 2023, which corresponds to when the Fed pivoted, and this has persisted with a strong earnings season supporting the prevailing positive sentiment in the market.
Looking at the decomposition of the market nowcaster for three different dates as represented in figure 2, there is more to this story. In October 2023, when markets hit a temporarily low point, each asset class was sending signals consistent with a recession, as once turned into a growth nowcasting signal they remained below 50%. Equities, commodities and currencies turned into a nowcasting signal are now hovering around 70% with the subsequent market recovery, while bonds are reaching the even higher level of 90%. With the recession scenario being abandoned since the end of 2023, according to those numbers markets no longer seem to be pricing a soft landing, but rather a no-landing scenario. The shift in monetary policy to a dovish stance and the good earnings season clearly played an important role in that upward momentum. At the moment, however, the macro data needs to further recover to help markets reach a higher level – or markets need to come to a more reasonable pricing of growth. Which will it be? This is the question of the week.
FIG 2. Decomposition of the market nowcaster into asset classes
Source: Bloomberg, LOIM. As at March 2024. For illustrative purposes only.
| Simply put, markets are increasingly pricing a no-landing scenario, but the macro data so far disagrees – one of the two has to give. |
Macro/nowcasting corner
The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises and global monetary policy surprises are designed to track the recent progression of macroeconomic factors driving the markets.
Our nowcasting indicators currently show:
- Our growth nowcaster rose slightly this week, especially in China where industrial profits rose in a sign of a stabilising economy
- Our inflation indicator remained unchanged over the week in the US and eurozone, with a small increase in China
- Our monetary policy indicator remained flat with a small decrease in the US
World growth nowcaster: long-term (left) and recent evolution (right)
World inflation nowcaster: long-term (left) and recent evolution (right)
World monetary policy nowcaster: long-term (left) and recent evolution (right)
Reading note: LOIM’s nowcasting indicator gathers economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).
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