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Some quant work on global cyclicality and equities (Wonkish)

I use three indicators in my work and analysis on the blog to describe the global business cycle; a weighted average of growth in global industrial production and trade, compiled by CPB, the global composite PMI, and a diffusion index of OECD’s leading indicators. Strictly speaking, the CPB data in this context are a coincident indicator, while the PMI and OECD LEIs are short-leading indicators. What’s the difference? At the moment the CPB data, updated through February, provide a guide of what happened at the start of 2024 and perhaps an early read on the Q1 GDP numbers, which have just started to trickle out. By contrast, the PMI and OECD LEIs are supposed to offer an early indication of what will happen in Q2. The distinctive lines between these definitions are fuzzy, so I tend to see these three as separate gauges of where global economic activity—with a weight towards developed markets—is right now.

But how do these indicators relate to the equity market? Let’s try to find out.

Cruising for a Bruising

Financial market pundits are a bit like dogs chasing cars; they wouldn’t know what to do if they caught one. And so it is that after trying to figure out whether the economy and markets would achieve a soft landing in the wake of the post-Covid tightening cycle, no one quite knows what to think now that the soft landing appears to have arrived.

Let’s list the key requirements for a soft landing.

What to do with high-flying tech at the start of 2024?

I am coming into 2024 in a decent position. My MinVar equity portfolio, designed to extract the best from both worlds in the perennial battle between growth and value, has done largely what it is supposed to do. It has offered positive, but below-beta, returns with below-beta volatility, the latter which means that your humble blogging investment analyst has been able to sleep calmly at night. In bonds, I moved my exposure onto the front early in 2023 in line with the yield curve inversion. At this point I see no reason to change that strategy. Why buy negative carry in duration when you don’t have to? There will be a time to take a strong bet on duration, but I can’t really see that point until either the front-end has collapsed under the weight of global central bank easing, or unless the curve rinses everyone by bear-steepening sufficiently to restore a positive roll and carry in the long bond. In other words, I don’t see any reason to buy duration as long as the curve is still deeply inverted.

Goldilocks

Someone has to say it, and it might as well be me. Markets have a distinct goldilocks feel about them at the moment, or in the words of the FT’s editors; markets are beginning to eye the “immaculate disinflation”, which is a prerequisite for a soft landing. This is a story about two trends; easing inflation and economies which are, well… neither too hot nor too cold. Soft US and UK inflation reports for the month of June have been key catalysts for the change in mood. Headline CPI inflation in the US fell to a two-year low of 3.0%, with core inflation dropping by 0.5pp, to 4.8%, a 20-month low. In the UK, meanwhile, headline inflation slipped to 7.9%, from 8.7% in May, while core inflation dipped by 0.2pp, to 6.9%. These numbers don’t exactly scream goldilocks, but markets trade at the margin of the economic data; it is the direction of travel that matters.

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