If you spend a good portion of your day looking at economic data, you’ll find some unusual numbers. Some releases have misleading names like the University of Michigan Consumer Sentiment Index, which doesn’t measure sentiment at the University of Michigan. 1 1 Close We have been asked why economists care so much about what a bunch of college students think. And why only Wolverines – couldn’t they interview a few Spartans or Buckeyes? The answer is that the index is a survey conducted by the University of Michigan, not of students there. Some are referred to by misleading names, such as the Empire Manufacturing Index, which does not measure activity in the building of empires. 2 2 Close This index was very strong in Italy around 44 BC. In fact, this index is actually the Empire State Manufacturing Index, which measures manufacturing in the Empire State (New York) area. There are some that seem to violate basic logic, like the ISM Non-Manufacturing Index of Business Inventories. What are inventories of things that are not manufactured? How can a barber keep an inventory of unused haircuts? 3 3 Close A service business can have inventories of equipment, but it’s not as clear what that means for future output. Finally, there are some that just sound good, like New Zealand’s ANZ Truckometer. It probably measures shipping or something, but investors may cite it just to say the name. 4 4 Close The ANZ Truckometer consists of a set of two economic indicators compiled by ANZ Bank that measure freight shipments throughout New Zealand. Because much of the transport in New Zealand is done by road, some economists think this is a good real time indicator of the economy there.
In the search for useful economic indicators, many people look at past results. While it may seem an obvious decision to use the indicators that had the best results or received the most reaction from markets, there is no guarantee that they will work as well in the future. 5 5 Close Do we need a disclaimer on this sentence, which already sounds like a disclaimer? For example, if you looked at the U.S. in the run-up to the financial crisis, you might find that housing data was the most predictive. At the time, mortgage financing and housing were at the core of the crisis. After the crisis, the direction of housing became less important to the economy and might not have moved markets as much. Learning from this experience, a researcher might conclude that the right way to approach economic data is to weight very recent performance more heavily and thereby capture the most recent trends. The problem with doing this is that economic data is very noisy and short-term fluctuations can be misleading. Any one number, or small set of numbers, can swing back and forth from positive to negative very quickly.
We would suggest that the best way to approach economic numbers is not to mine the data, but rather to take a broad set of numbers and create a more balanced grouping. 6 6 Close Or as broad of a set as you can find. Such an approach can avoid the pitfalls of short-term narrow views and at times provide a clearer view of the direction of the economy.
One of the primary ways investors look at economic numbers is how they perform relative to expectations. Many sources compile so-called surprise indexes, which track cumulative hits and misses of economic data releases compared to economists’ forecasts. Our research shows that in large groups of data, positive surprises are often followed by more positive surprises. 7 7 Close And negative by negative surprises. In other words, economists can be slow to adjust their forecasts to changes in the economy, which creates a bias. Looking at these surprises is another way of catching trends in the economy that may not appear in the releases by themselves.
Recently, the data in the U.S. has been generally strong while European data has been weak. In surprise indexes we construct internally, we find a more nuanced picture of the economy. 8 8 Close Our surprise indexes compare actual economic data releases to forecasts and then the differences are aggregated. Sources: AQR, Bloomberg. In the U.S. we see very strong positive surprises in numbers related to sentiment. This category includes the University of Michigan number as well as surveys from the Conference Board and others. Other numbers are not as clear. Even though inflation has not been high, data related to prices 9 9 Close Price data includes measures such as CPI and PCE. Sources: AQR, Bloomberg. has generally been coming in a little above expectations. Output and employment surprises have been mixed, even though both employment and output have seemed strong on an absolute basis. 10 10 Close Output and employment data includes measures such as GDP, Retail Sales and Unemployment Rate. Sources: AQR, Bloomberg.
A few months ago, the picture was very different. Both output and employment were surprising higher. What this may mean is that we are starting to see a shift in the economy. Output is still good but may be starting to slow a bit. However, with sentiment continuing to surprise upwards, consumption is likely to stay strong in the short run, perhaps making for a decent holiday season, despite some anecdotal evidence otherwise. If employment surprises start to go negative, then sentiment numbers could become vulnerable to negative surprises. This is worth watching in the coming months and would be a strong warning signal about the economy.
European surprises tell a different story. Output surprises in Germany and other countries have been very negative in the past year. In this case, economists may have gotten ahead of themselves after a very strong run in 2016 and 2017. They may have mistaken a cyclical recovery for a longer-term increase in growth and have been too slow in adjusting their forecasts back to the reality of the economy. Surprises in other areas, such as employment and inflation, have been less conclusive for markets than the first 12 games of the Carlsen-Caruana match. 11 11 Close Magnus Carlsen and Fabiano Caruana drew 12 straight games during normal length play of the World Chess Championship, a first in the history of the Championship. Carlsen ended up defeating Caruana in a tie-breaker round – a best of four rapid game series – winning three straight games. It’s been all about output on the continent.
Investors are right to be more cautious on growth as the surprises have turned neutral. However, we would argue against trying too hard to twist the numbers into the common narratives about growth and the cycle. Specifically, we would avoid any narrative that talks about one number as the leading indicator to look at – like some obscure statistic that foretold of the last crisis. The broader set of numbers shows a mixed picture, which is usually a more accurate description of the economy. It may seem odd that markets that are heavily sentiment driven have sold off even as surveys have been surprising to the upside. But this type of dissonance is not uncommon, particularly when the data is not conclusive. It may give some hope that markets will come in line with the data, rather than the other way around. Or maybe it says that the surveys should talk to people from schools other than the University of Michigan. Either way, be careful in playing favorites with economic data.
What We Are Watching
G20 Meeting (Friday, November 30 and Saturday, December 1) G20 meetings tend not to be major market events, but the upcoming gathering in Argentina is of interest to investors due to planned talks between the U.S. and China on the sidelines of the conference. While it is difficult to precisely gauge expectations, investors may be hopeful that bilateral talks between President Trump and President Xi at the G20 will open the door to de-escalation in the trade dispute between the two countries. A comprehensive trade deal appears unlikely in the near term, but a public statement promising continued talks could have a positive impact on market sentiment, particularly if U.S. officials put scheduled tariff increases on hold while talks proceed. Such an announcement might provide a boost to equities in the U.S. and China as well as other assets sensitive to Chinese growth, such as the renminbi and base metals. If no progress is made at the G20, market participants may conclude that trade barriers between the U.S. and China will continue to increase.
U.S. ISM Manufacturing PMI (Monday) and Non-Manufacturing PMI (Wednesday) U.S. growth numbers have looked quite strong this year, but recent equity market declines and a slowdown in European data have fueled concerns that the U.S. economy may begin to lose momentum. In a speech this week, Fed Chair Powell gestured towards such concerns, noting that “there is no preset policy path” and officials “will be paying very close attention to what incoming economic and financial data are telling us.” 12 12 Close Chair Powell: “The Federal Reserve's Framework for Monitoring Financial Stability,” 11/28/18. If the U.S. does start to slow down, surveys such as the Manufacturing and Non-Manufacturing PMIs published by the ISM may provide the first indications. Negative surprises in one or both of the two indexes could lead to gains in U.S. fixed income as markets scale back expectations for future Fed hikes.
U.S. Employment Report (Friday) Recent employment reports have shown solid job growth above 200,000 per month and unemployment at its lowest level in nearly five decades. 13 13 Close The latest nonfarm payrolls employment report released on November 2, 2018 for the October period showed an addition of 250,000 jobs and the unemployment rate at 3.7%, the lowest level since 1969. Sources: Bloomberg, Bureau of Labor Statistics. A tight labor market finally appears to be driving faster wage growth, with average hourly earnings up 3.1% YoY in October, the largest annual increase since 2009. If wages continue to accelerate, it could weigh on corporate profit margins and may also drive an increase in broader inflationary pressure. Upside surprises in average hourly earnings may therefore trigger a negative reaction in both stocks and bonds. At this point in the cycle, markets may actually respond favorably to a modest slowdown in job growth, which might lower the perceived risk of labor market overheating.