investment viewpoints
Can positive US growth keep surprising equity markets?
The current equity rally mainly reflects two factors: first, declining 10-year rates since November have supported valuations and reduced the risk of corporate credit defaults; second, positive growth surprises have recently lifted the market. This might leave investors wondering: with valuations considerably higher than at the start of Q4 and interest rates seeming to stabilise at levels higher than a decade ago, can growth alone keep supporting the markets?
This week, Simply put questions the potential for (positive) surprises in global economic growth as China struggles to revive output and the eurozone seeks a stronger footing. So far, US GDP and corporate earnings have beaten expectations and driven equity markets. Should we expect these positive surprises to continue?
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Surprises and indices
As we know, the valuation of financial assets evolves according to ‘surprises’: discrepancies between the reality of figures or phenomena and how they are anticipated by markets. In the case of growth and other economic metrics, market expectations are approximated by medians calculated on the basis of forecasts by a group of economists. The difference between the published growth figure and this median can then be combined with other discrepancies to form surprise indices developed by various providers.
Surprise indices are typically oriented towards the foreign exchange market of a given economic zone. For example, US growth-surprise indices are gauges of surprises in statistics that influence the dollar. Figure 1 shows various growth-surprise indices for the US, allowing us to follow the cycles of these surprises over time. As can be seen, these surprises were strongly positive in the middle of 2023 and surged again in early 2024. This has led market observers to build a positive view of the cycle and, therefore, on risk assets.
But these positive surprises have recently reversed – notably with the publication of the ISM manufacturing and services indices. Is this cause for concern?
FIG 1. US economic surprise indices focused on growth
Source: Bloomberg, LOIM at March 2024. For illustrative purposes only.
Diffusion and surprises
These positive and negative surprises don't just strike out of the blue. A large proportion simply reflect cycles of improvement or deterioration in macroeconomic news flow. Our nowcasting indicators (see below this article) are each accompanied by a diffusion index: the percentage of improving data within the underlying economic figures. A diffusion index above 50% is an indication of an improving economic trend. The higher the figure, the greater the improvement is likely to be, as larger proportions of data converge to indicate a positive move.
Figure 2 shows the day-by-day evolution of the diffusion index of our US growth indicator. It shows that the two periods of positive economic surprises we discussed previously – in mid-2023 and early 2024 – correspond to phases of improving economic data. Amid the negative surprises in Q4, the diffusion index was close to 40%.
Recent developments give cause for concern. Since late February, not only have economic surprises turned negative after being strongly positive for almost three months, they coincide with data indicating declining growth overall. This setback should raise questions for us as portfolio managers: if broadly improving economic data and positive surprises recently underpinned the rally, what should we infer from deteriorating data and negative surprises? This trend alone cannot explain a market reversal, but it is one of the red lights flashing in our portfolio-management cockpit.
FIG 2. Percentage of improving US economic data
Source: Bloomberg, LOIM at March 2024. For illustrative purposes only.
| Simply put, with US macro conditions seemingly deteriorating, one of the forces driving the equity rally is potentially in retreat. |
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:
- Growth has declined recently, mainly as a result of US data
- Inflation remains stable amid continuing disinflation
- Monetary policy remains dovish, particularly 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 indicators gather 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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