investment viewpoints

Is it time to be optimistic?

Is it time to be optimistic?
Florian Ielpo, PhD - Head of Macro, Multi Asset

Florian Ielpo, PhD

Head of Macro, Multi Asset

One of the key features of the summer rally has been the surprising resilience of the US economy. An easy way to assess this improvement involves looking at ‘surprise indices’ that measure the cumulative difference between published economic numbers and economists’ expectations.


Need to know:

  • Economic surprise indices have risen on the back of better-than-expected US economic news, partly caused by overly pessimistic expectations being dispelled by improving economic data
  • The withdrawal of excessive pessimism has helped risk assets – but too much optimism could eventually weigh on valuations
  • With expectations of a soft landing rising again, the risk of positive sentiment overshooting economic reality should be considered in asset-allocation decisions


Expectations versus trend

Since June, global growth has clearly been catching economists (including us) off-guard, with data being better than expected. It is important here to differentiate between an improving situation and a better-than-expected one. Growth can surprise on the upside for two reasons: because expectations were too low or because the situation improved beyond positive outlooks. The diffusion indices of our nowcasting indicators can help measure economic improvement and deterioration, making it possible to cast light on the current reasons for this apparent resilience of the US economy and, eventually, its longevity. 

Here we delve into an analysis of economic expectations versus trend.

Economic surprises are positive in the US

A wide variety of surprise indices are provided by banks. They portray economic surprises using a weighing scheme based on the sensitivity of local foreign-exchange markets to such surprises – hence the existence of USD or EUR indices. The Citi surprise indices or their Bloomberg counterparts are probably the most widely used these days. As mentioned above, some of the variations among them are due to the dynamics of improvement or deterioration in each country or zone, and from expectations that are set either too low or too high. 

A simple way to distinguish between the two consists of comparing these surprise indices with changes in growth conditions – as measured, for example, by our nowcasting indicators. Figure 1 compares our US growth nowcaster’s diffusion index (highlight improving and deteriorating economic conditions) with an aggregation of surprise indices for the US. It does so over a long period of time (2006-2023) but with a focus on the past two years. The chart clearly highlights the correlation between the two series over the longer run: in 2008, the macro deterioration came with disappointing macro data. In 2015-2016, a similar situation happened. In 2021, the macro improvement came with a positive surprise, as during the 2009 recovery. 

We have seen a different picture emerge over the past two years. Over the first half of 2022, periods of improvement and deterioration coincided with positive and negative surprise periods. However, since June 2022, the economic deterioration (as captured by ISM numbers, for example) has been met with positive surprises – which is a whole different situation. We can see from figure 1 that such a situation has only happened once before over that period: in 2006, when economic conditions deteriorated but surprises were positive. That period had something in common with our current situation: a hawkish Federal Reserve was attempting to curb inflation, but the full impact of its actions took time to manifest in the data.

FIG 1. Global economic output vs the LOIM US Growth nowcaster’s diffusion index

2006 to present, monthly data

December 2021 to present, daily data

Chart 1.svg

Source: Bloomberg, LOIM as at August 2023.

The current contradiction

The most recent period shows an evolution of a different kind, with positive surprises and an economic improvement – marking a clear change in the configuration of both indicators. Figure 2 shows how this relationship between surprise and diffusion indices has progressed over the past 12 months. 

It conveys how a period with (overly) optimistic economic forecasts in the context of decelerating growth (Q3 2022) and given way to a situation with pessimistic economists in the context of deteriorating growth (from Q4 2022 to H1 2023). And this pessimism persists amid early signs of an economic improvement. This has no comparison with the 2006-2023 period – no wonder why the current situation is described by many economists as a period of heightened economic uncertainty!

FIG 2. Surprise indices vs the LOIM Growth nowcaster’s diffusion index (% of improving data)

Chart 2.svg

Source: Bloomberg, LOIM as at August 2023.       

Why is this important?

This analysis of pessimism and optimism is essential to understanding today’s situation. A lot of the recent price action, be it on the equitiy or on the rates side, links to markets’ surprise at the resilience of the US economy.

Figure 3 shows how over the past two years, the S&P 500 has tracked the ups and downs of our diffusion index. Part of the recent rally coincides with improving economic data (either leading or lagging our indicator), resulting in economists being found to be overly pessimistic. This situation must have played a role in the pace of the rally, as conservative positioning did: wary investors and economists have been surprised by the extent of the recent rally. 

Assuming now that the investment community gets convinced by the possibility of a soft landing, the reverse could happen: overly optimistic investors and economists could be disappointed by the deteriorating economic news flow. Should that happen – for instance, with the publication of the US ISM data in September – this sentiment-driven rally could turn for good. It is probably too early to expect something like that, but as much as this mechanism helped markets gain considerable upside (while weighing on fixed income in the meantime), its reversal could cost dearly now that risk assets are more expensive. 

FIG 3. US Growth diffusion index vs S&P500 price over the past two years

Chart 3.svg

Source: Bloomberg, LOIM as at August 2023.

Simply put, markets are currently being driven by sentiment and overly optimistic expectations could eventually exert a negative impact.



Nowcasting corner

This section gathers the most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary-policy surprises. These indicators keep track of the most recent macro evolutions that make markets tick.

Our nowcasting indicators currently point to:

  • Despite the majority of economic data trending higher, our growth nowcaster declined marginally over the past week. The deterioration in China contributed notably
  • Our inflation signal rose over the week, in line with the 67% of rising data that mainly reflects re-building inflation pressures in the US
  • Our monetary policy indicator declined this week, essentially as Chinese newsflow added more pressure on the nation’s central bank, which cut rates consistently in response


World growth nowcaster: long-term (left) and recent evolution (right)

Chart 4a.svg

World inflation nowcaster: long-term (left) and recent evolution (right)

Chart 4b.svg

World monetary policy nowcaster: long-term (left) and recent evolution (right)

Chart 4.svg


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). Source: LOIM analysis as at August 2023.

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