Side Views

Keeping pace with leading global economic indicators — Oh Boon Ping

MARCH 17 — Economic indicators are data points which tell us about the state of an economy. Economists and analysts often refer to economic indicators when they present their analysis of future performances of countries or regions.

However, not all economic indicators are equally important. Leading economic indicators, in particular, usually signal an adjustment before the economy as a whole changes. They are therefore especially useful as short-term predictors of the economy.

So which are the important indicators you should take note of as an investor? And what are today’s leading economic indicators telling us now?

The first important global leading economic indicator investors can look at is the Citi Economic Surprise Index. It is an objective measure on whether economic announcements or releases have beaten the consensus view of analysts. Recently, this indicator has been increasing, or trending up, implying that the global economic outlook is not as weak as previously thought.

This is important as research has shown that making the right call on macroeconomic conditions can be very profitable, particularly at a turning point. For example, if stock investors could have foreseen the last economic downturn as early as December 2007, most would have avoided the 38.6 per cent drop in the Dow Jones Industrial Average which occurred in the next nine months.

The United States is currently the world’s largest economy and can have a major impact on the world. Therefore, tracking key forward-looking US indicators such as the US Initial Jobless Claims Index and the US ISM New Orders minus Inventory Index can also be a very useful exercise as they warn of the economic hazards ahead.

US Initial Jobless Claims Index

This metric measures the number of people in the US who have filed for unemployment benefits for the first time. Geoffrey Moore, one of the pioneers in US business cycle research, believes that the average weekly jobless claims were five months ahead of the economic cycle peak, and one month ahead of the bottom of the cycle.

The US Initial Jobless Claims Index has shown that the economy has been improving since December, with the Index remaining below the key 400,000 level. Readings below that level suggest that the job creation process is finally picking up steam and helping to mop up the excess labour in the market.

This is important because more people at work means that potentially more money will be spent. Consumption spending alone accounts for up to 70 per cent of US gross domestic product (GDP).

The steady improvement in labour market conditions will hopefully set in motion a virtuous circle of improved sales, higher corporate profits, more jobs created and increased consumption spending.

US ISM New Orders Minus Inventory Index

As anyone who has worked in manufacturing will tell you, new orders are the lifeline of factories. New orders generate sales and profits, but this has to be offset by existing inventories. Factory producers will typically meet new orders by first drawing down on existing stock. Only when stock levels have run low, will manufacturers tap the production lines for a supply of new products.

Our analysis shows that the US ISM New Orders Minus Inventory reading is a good nine-month leading indicator for US GDP growth. The latest reading marks a reversal from the decline seen in previous months. Assuming that the metric continues to lead the economic growth by about nine months, we may see a respectable bounce from a cyclical weakness in the first half of this year, even though momentum may moderate in the second half.

Consumer Confidence Index

Spending by consumers is one of the key contributors to aggregate spending (which shows much money is being “spent” on a country’s economy). Therefore, it is important to monitor how consumers feel about their economic prospects. There are two respected consumer confidence surveys available in the US — the University of Michigan Confidence Survey and the Conference Board Consumer Confidence Index.

Both sets of numbers are holding up, despite the lacklustre economic data in the US, and negativity from problems in Europe. However, that could change quickly if the situation deteriorates rapidly.

Other Leading Economic Indicators

There are also a number of other forward-looking indicators around the world that are worth tracking.

At the top of the list is the Purchasing Managers’ Index (PMI) which is available in various countries. This is the equivalent of the US ISM Index, and it is a health barometer for the manufacturing sector. Although the services sector continues to dominate in terms of share of GDP in many countries, the bulk in the swings in economic growth have come from factory production, therefore making it an important indicator to watch.

Latest PMI readings from Germany, France and China show a slight recovery in industrial activity in recent months. In the case of France, the index recovered from the contraction mode seen late last year (this is when the index falls below 50 marks). Although this does not preclude the possibility of a euro zone downturn, it suggests that the slowdown may not be as bad as initially thought.

China’s official PMI has shown a brief rebound, even though the index has been decreasing, or trending down, for the past few months. Given the concerns over the asset price bubble in its property market, there is a risk that China’s economy may end up in a hard landing scenario because of the spillover effects on the banking sector.

In summary, it is important that investors track leading economic indicators as they serve as guideposts on the investment outlook ahead. So far, the leading economic indicators point to a possibility of a downturn in France and Germany, although the US is likely to muddle through despite the risks of headwinds from Europe. China’s PMI indicates it is recovering from the cyclical weaknesses seen previously, pointing to a soft landing scenario.

The generally positive readings in leading economic indicators tie in neatly with the signs of gradual improvement in economic data and liquidity in many parts of the world.

Since January, equity markets across the world have largely rebounded from the lows seen last year. Also, gold and most commodities have performed well while bonds have held their own. The S&P 500 has crossed the 1,300-point level, while the Dow continued to march upwards, nearly touching a four-year high last set in May 2008.

These developments suggest that the market rallies may have more legs. In light of this, UOB Asset Management has realigned its asset allocation weightings to “overweight” for equities and commodities, and “underweight” for bonds and cash. — Today

* Oh Boon Ping is the manager for asset allocation at UOB Asset Management.

* This is the personal opinion of the writer or publication. The Malaysian Insider does not endorse the view unless specified.

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