Stocks: Anticipator of Economic Health?
Stock markets are again heading north while market commentators question the health of the world economy and especially the situation in the U.S. But who is right and who is wrong? This very question prompted me to look at the ability of stock markets to anticipate the fortunes of the underlying economies.
In previous blogs I emphasized the importance of the U.S. stock market as a component of the ECRI Weekly Leading Index (WLI). For the purpose of this study, I have used the same algorithm previously used to track the WLI's Smoothed Annualized Growth Rate but changed it to a monthly basis instead of weekly. I call it a Monthly Smoothed Annualized Growth Rate or MSAGR for short.
In the graph below, I have depicted the MSAGR of the S&P 500 Index against the 12-month momentum of the USA Composite Coincident Indicator and it appears that the MSAGR of the S&P 500 leads the coincident indicator and therefore the U.S. economy by approximately four months.
Sources: I-Net; Plexus Asset Management.
What is remarkable is that in all instances when the MSAGR fell below zero, growth of the U.S. economy as measured by the coincident indicator declined approximately four months later, except in 1994 when the MSAGR only briefly turned negative.
As in 1994 the MSAGR briefly turned negative in August this year at -1.17% but bottomed and soon moved to positive territory again. The message I am getting is that the slowdown in growth of the U.S. economy in recent months is something of the past and that the first quarter of 2011 will show improvement. It is clear that those at the Fed are heavily influenced by the trend in the stock market and therefore felt strongly about implementing QE2 to prevent the ship from sinking.
Using the same algorithm, I calculated the MSAGR for the MSCI World Free Index in U.S. dollars and compared it to the 12-month momentum of the OECD Leading Indicator. While there is a close relationship between them, the MSAGR of the MSCI World Free Index is in fact more reliable than that of the OECD Leading Indicator. It was especially evident in 2002 when the OECD Leading Indicator's momentum turned positive while the MSAGR stayed in negative territory and therefore did not fall into the trap of the double-dip in global economic activity. In fact, since the start of this year the MSAGR of global stocks has led the OECD Leading Indicator's momentum.
Sources: I-Net; Plexus Asset Management.
What is going on in emerging markets?
My MSAGR of the MSCI Emerging Market Index in U.S. dollars had a solid uptrend that started when the Asian crisis ended at the end of 1998 but collapsed in 2008 with the Lehman saga.
The MSAGR of the MSCI Emerging Markets Index in U.S. dollars follows the same trend as that of the MSCI World Free Index in U.S. dollars. The growth is more elevated, though, and indicates the stronger growth in emerging economies compared to mature economies. It is interesting to note that unlike mature markets the MSAGR of emerging markets did not bottom in negative territory.
Sources: I-Net; Plexus Asset Management.
Looking at individual emerging economies and specifically my home country, South Africa, it is evident that the MSAGR of the South African stock market in local currency (rand) terms leads the economy as measured by the momentum of the SA Coincident Indicator by approximately four months. The MSAGR therefore points to the slowdown in growth of the SA economy bottoming in the final quarter of this year and activity strengthening in the first quarter of next year.
Sources: I-Net; Plexus Asset Management.
Bottom line: The stock market is probably right regarding an improved global economic outlook for the first quarter of next year. Sentiment can turn quickly, though. With a number of black swans on the radar I will watch the MSAGRs of the different markets very closely.
Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.
Tweet
Author: Prieur du Plessis
Dr Prieur du Plessis
investmentpostcards.com
With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.
He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).
Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.
Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.
Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.
In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).
Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.
Copyright © 2008-2012 Dr Prieur du Plessis
Circle Us