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Leading indicators point to a start of a recovery

28072020

History has shown that there is a correlation between current and future asset returns and economic activity. This relationship highlights the importance of considering economic expectations in determining the stage of the economic cycle and forming capital market expectations going forward.

Attention has shifted to forward looking indicators, as a means to assess the trajectory of the economy. When considering the rapidity at which the pandemic situation continues to evolve, higher frequency data that tracks the economic reopening has gained investors attention. Google and Apple, for example, are regularly issuing mobility reports to track people’s movements throughout the pandemic. Real-time data has shown that America still records lower activity to workplaces and usage of public transport while retail and recreation activity in Germany have practically returned to normal.

More traditionally, economic data which moves ahead of the business cycle is classified as leading. The Purchasing Managers’ Index, for instance, captures the change in economic trends, gauging the trajectory of business conditions. As economies continue to reopen from lockdowns, economic data, most especially in Europe has continued to improve over the past weeks. Despite that France was among the hardest hit in Europe, during the peak of the covid-9 pandemic, the composite PMI for July recorded an expansionary reading above the 50 level of 57.6. Overall, the Eurozone Composite PMI for the month jumped to a 25-month high and beat market expectations. Both the manufacturing and services sectors returned to growth and business expectations were reported to have increased in the euro area.

Meanwhile, PMI readings for the US were relatively weaker for the month of July, weighed down by the services sector, which recorded the sixth month of contraction. Last week’s unemployment numbers also raised concerns that the recovery in the US labour market is stalling by the resurgence in new covid-19 cases. New weekly unemployment claims accelerated for the first time in nearly four months and exceeded market expectations as several states were forced to scale back or pause the reopening of their economies.

Although leading economic indicators can be analysed individually, economic activity is very wide in nature, dependent on consumer behaviour, policy action, business expectations and trade relations. Composite Leading Economic Indicators (LEI) record a more aggregate view of the economic trajectory. Recently, the OECD published its own composite LEI, based on a number of variables, including manufacturing metrics, inflation, interest rates, and monetary data. Over time, this composite has shown to have preceded economic turning points by approximately six months.

In its latest report, the OECD recorded a strong rebound in most large economies, however, the indicator still remains below the levels recorded prior to the coronavirus outbreak and well below long-term trends. Regionally, both Europe and the US are exhibiting signs of an easing slowdown, however the strength of the signalled recovery in Europe was recorded to be stronger than that of the US. China, on the other hand, which was the first country to enter and exit from lockdowns, exhibited signs of growth regaining momentum.

While economic growth is expected to contract in 2020, economic activity follows a cycle: with the start of initial recovery following the trough. Evidently, leading economic data has already shown signs that the economies are picking up. Nevertheless, the resurgence of hotspots across US states, such as Florida, Texas and Arizona and even rising concerns over Spain’s recent spike in cases underscore how much post lockdown virus control and the economic recovery remains fragile.

Disclaimer:

This article was issued by Rachel Meilak, CFA Equity Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

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