investment viewpoints
What are the investment cycle’s next steps?
If we were to summarise the second quarter in a single sentence, it would likely be: economic growth was encouraging, but sales growth was disappointing. Today, the misalignment between ‘macro’ and ‘micro’ is quite evident in the daily data collected. This was also the case in 2023, when macro indicators pointed to a slowdown, while the performance of listed companies surged.
It remains the same today, with GDP growth surprising on the upside across the Atlantic, while global stocks’ sales growth shows disappointing moderation. This season has been all about artificial intelligence (and the fervour surrounding it), when in fact 50% of companies reported results that were either in line with or below expectations1.
This troubling situation should prompt investors to question what to expect from the two engines of the investment cycle – the macro and the micro – in the coming months. Can our nowcasting indicators provide a clearer answer than other indicators offer? This week, Simply put offers a 360° macro perspective on which direction the cycle is heading.
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Need to know:
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Hopes and fears
When trying to gauge the trajectory of the economic cycle, rather than relying on a large amount of aggregated data, it seems important to identify and review the elements that illustrate the complexity of the current situation. Each economist fetishises over certain indicators that they trust, especially when the direction of a cycle is in doubt. These indicators are often similar:
- In the US, the Manufacturing ISM is the most followed survey, as it contains various components, some of which are ‘lead’ more than others. The ‘new orders’ component is one of these and, once smoothed, it reveals a clear message (see Figure 1). After declining in 2023 to levels as low as those at the bottom of the US dotcom crisis in 2001, the series has resumed its ascent and is now approaching its long-term average. The recent volatility of this survey should raise alarm bells for any respectable economist, amid oscillations between 45 and 52 (50 being the level separating an expanding from a slowing economy). If this indicator usually provides a robust signal of which stage in the cycle we are in, current readings imply a sense of uncertainty is understandable. Its latest reading missed estimates, triggering resurfacing doubt regarding the future of US growth.
- In Europe, there is no specific equivalent to the Manufacturing ISM. Commentators often resort to the ‘HCOB PMI’ when following the European cycle, but this series is not calculated by a public entity and it should be noted that in the US the PMI is not followed as closely as the ISM. Economists can also access a set of surveys from the European Commission that admirably fulfil the objective of the ISM. Figure 1 shows the evolution of the manufacturing confidence survey in Europe since 1980, and it clearly shows the variations of the European cycle. Recently, this survey has retracted without falling below its long-term average (-10). It’s clear that the eurozone economy has slowed down, but not to the same extent as in 2008 or 2011. The latest readings of that survey nonetheless conveyed slower economic activity across the board.
Beyond these two important markers of the cycle, it remains easy to be nervous about the second half of the year. Economic surprise indices are now negative on both sides of the Atlantic. France’s latest retail sales are much weaker than expected. The German IFO was disappointing and continued to highlight the weakness of a Sinocentric Germany. On the American side, Federal Reserve (Fed) surveys point in different directions. Those from Dallas and Chicago underline a resilient economy, and the Philadelphia Fed reports an acceleration in the manufacturing cycle. Meanwhile, the Richmond Fed points to a slowdown, as does Kansas.
These signals clearly point in all directions, and it is difficult to know which macro series to trust. We therefore need look for information that aggregates these differences to extract a common message. Luckily, this is the very essence of our nowcasting indicators.
FIG 1. American ISM 'new orders' component (left) and European Commission manufacturing confidence survey (right)
Source: Bloomberg, LOIM. As of 05 August 2024. For illustrative purposes only.
The importance of consensus
It is precisely to avoid having to choose a ‘best in class’ indicator, which risks leaving aside relevant information from other economic series, that underlines why nowcasting indicators are so useful.
From the perspective of the Fed, few of its indicators have endured over the years, but the Atlanta Fed’s indicator continues to be followed by market economists. This indicator aims to ‘nowcast’ American growth itself, and its current message is that growth for the third quarter could be close to 2.8%2. Our nowcasting indicators do not have the same ambition: they are cycle indicators, aiming to estimate what phase of the cycle we are in. However, historical regressions can allow this cycle indicator to be transformed into an estimate of growth.
Figure 2 illustrates the outcome of these estimates and compares them to the growth actually achieved, as well as to the Atlanta Fed’s GDPNow indicator. For the US, the results are similar: our nowcaster indicates the cycle is low but still marginally improving, a phase during which growth that’s higher than potential can occur. Our calculations point to 2.2% annualised, which is close to the GDPnow’s 2.5%. For Europe, the same is true: the indicator oscillates around 50% but is picking up. Again, such a recovery phase could generate growth of around 1.5% in annualised terms, or about 0.4% for Q3. After a sequence of 0.3% growth in the first and second quarters of this year, such an outcome could surprise pessimists about growth in the eurozone.
These two indicators comprise 70 and 39 indicators, respectively, for the US and the eurozone, and encompass the various major economic concepts that form the engines of their respective growth. The message is generally that these two economies are showing some resilience, with different levels of structural growth, but the terrain is potentially conducive to positive growth surprises in both regions as the Fed and the European Central Bank (ECB) end their restrictive monetary policies. This potential situation is not to be underestimated. More recently, a breadth of data has started showing signs of an upcoming deceleration – an important change in direction that we will keep monitoring through our nowcasting indicators.
FIG 2. Expected growth by our nowcasting indicators versus actual growth in the US (left) and the Eurozone (right)
Source: Bloomberg, LOIM. As of 05 August 2024. For illustrative purposes only.
What this means for All Roads
While markets have recently experienced a period that is conducive to drawdown management systems being implemented as trends recede, our strategies have maintained significant market exposure and our preference for cyclical assets remains steadfast. It will take more concrete indications for our solutions to shift from this overweight and start to seek refuge in bonds and cash. At the moment, the macro part of our signals entertains a low but defensive positioning due to the ‘low and stable’ growth indication. As ECB President Christine Lagarde says regularly, let’s keep in mind the difference between ‘data points’ and ‘data’ as the growth picture remains unclear for now.
Simply put, economic indicators have been mixed lately, but their collective message points towards a resilient cycle.
[1] Source: Bloomberg, as at 31 July, 2024.
[2] Atlanta Fed, as at 31st July, 2024
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 signal has remained largely unchanged, reflecting divergences between indicators – over 50% of the collected growth data shows progress: here, too, uncertainty remains
- Our inflation indicator continues to rise and is now at the threshold of 50%
- Our monetary policy signal remains in the lower part of its neutral zone as we anticipate the first rate cut for the Fed in September – nothing in our signals currently opposes this
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 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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