Leading indicators-What are They Telling US?

A couple of weeks ago, a post in the Financial Armageddon (Michael Panzner) blog titled “Recipe for Disappointment” caught my attention. It discussed how the US Leading Indicator is surpassing the Coincident Indicator by a record amount or as Michael Panzner wrote, “hope has outpaced reality to a degree that has not been seen over the course of five decades.”

Most people tend to only look at the headline number and pay little attention to the detail when it comes to indicators such as the leading index. With a statement like the one above, it’s worth taking a closer look to see if “hope” is that misleading. The Conference Board’s leading index is composed of 10 indicators (2 employment related, 3 manufacturing, 1 housing, 1 equity prices, 2 monetary and 1 sentiment).

What’s driving the leading index for the gap with the economy to widen so much? It sure isn’t employment and manufacturing, albeit both are improving. Stock prices have definitely played a major role but more importantly, it’s the interest rate spread. In fact, liquidity/market related indicators now make up 50% of the leading index. Meanwhile, unlike what some may think, M2 growth continues to head south which is not a good sign. The past year, many economic critics talked about the inflationary risk tied to rapid monetary base growth. However, this statistic is meaningless if the banking system is not operating. Look at Japan in the past.

As for the coincident index, it’s made up of only 4 indicators (2 employment and 2 manufacturing)…Given the structure of the US economy, it shouldn’t be surprising that employment related indicators are 73% of the index. As the US is caught in a jobless recovery, that alone will cause the gap between leading and coincident index to widen a record amount.

What’s creating this jobless recovery? Well, the lack of an efficient financial system can be blamed. If the system was operating on all cylinders, money growth would not be slowing down and lending growth wouldn’t be negative. In other words, reality would be catching up to expectations as in the past.

Given the rapid rise in the leading index, will it start to lose momentum or will the improving trend continue? If employment conditions fail to improve and banks remain tight, the drop in equity prices and sentiment are a couple indicators that would start to weigh on growth momentum. Meanwhile, the coincident index would obviously not recover in this case…If the leading and coincident indexes are any sign of current and future growth, it all comes down to jobs in 2010.

Last week, the January labor report offered some encouraging signs but a few more months of similar data are required to be convinced the job market will keep improving. If the recovery in corporate earnings were to encourage companies to start hiring again, January marks a new year for that to begin. However, it takes more than a month for jobs to be filled. Meanwhile, small companies suffering from depressed demand and faltering credit are being forced to close and this will continue to add to the unemployment line. In January, 20,000 jobs were lost (mfg. +11,000, construction -75,000, transportation -19,000, state/local governments -41,000, health care +17,000, retail +42,000, services +44,000). It will be important to see how February and March pan out.

As the Conference Board statistics are not free of charge, without the benefit of Datastream, Bloomberg, etc. as data resources, I decided to take a look at OECD global leading indicators. It puts the US recovery into some perspective as well…According to the latest OECD Leading Indicators, growth in these numbers on a global scale is definitely surpassing any cycle in the past decade. Germany is leading the pack of developed countries but overall, the rebound in leading indicators is quite dramatic. From the chart below, the only cautious note goes to China. As you can see from past data, though, it’s difficult to read much into it given the limited growth momentum suggested for China prior to 2008.

What does the leading index actually tell us about the real economy? Looking at a chart of OECD Leading Index to OECD Real GDP, it’s pretty clear the leading index has forewarned of peaks and troughs months in advance. The good news is that up to December, there is still no sign of a downward trend developing! It’s pointing straight up!

With the markets nervous about a PIIGS crisis, here is a look at their leading indicators. As you can see from the chart below, Portugal, Italy, Spain, and tack on Netherlands, are all witnessing the same positive trend as other major countries. However, Greece and Ireland are crawling along the bottom. From the looks of this chart, something tells me more than a few words of support for Greece will be needed in the end.

Revision to Standardization factors effective January 2009

Leading Economic Index Factor

• Average weekly hours, manufacturing (0.2549)
• Average weekly initial claims for unemployment insurance (0.0307)
• Manufacturers’ new orders, consumer goods and materials (0.0774)
• Index of supplier deliveries – vendor performance (0.0677)
• Manufacturers’ new orders, nondefense capital goods (0.0180)
• Building permits, new private housing units (0.0270)
• Stock prices, 500 common stocks (0.0390)
• Money supply, M2 (0.3580)
• Interest rate spread, 10-year Treasury bonds less federal funds (0.0991)
• Index of consumer expectations (0.0282)

Coincident Economic Index

• Employees on nonagricultural payrolls (0.5439)
• Personal income less transfer payments (0.1873)
• Industrial production (0.1497)
• Manufacturing and trade sales (0.1191)

Previous factors taken from Conference Board BCI Handbook 2001

Leading Indicators Standardization Factors

• Average weekly hours, manufacturing (0.1899)
• Average weekly initial claims for unemployment insurance* (0.0240)
• Manufacturers’ new orders, consumer goods and materials (0.0489)
• Vendor performance, slower deliveries diffusion index (0.0271)
• Manufacturers’ new orders, non-defense capital goods (0.0125)
• Building permits, new private housing units (0.0184)
• Stock prices, 500 common stocks (0.0304)
• Money supply, M2 (0.3034)
• Interest rate spread, 10-year Treasury bonds less Federal funds (%)(0 .3274)
• Index of consumer expectations(0 .0180)

Coincident Indicators

• Employees on non-agricultural payrolls (0.4790)
• Personal income less transfer payments (0.2830)
• Index of industrial production (0.1290)
• Manufacturing and trade sales (0.1090)

Related articles

• Recipe for Disappointment
• U.S. Economy: Leading Index Rises More Than Forecast

Weekend Readings: Greece needs help, but who? – China insight – Paulson’s New Book – How to stop reform…

Greece

• IT’S ALL ABOUT DEBT - TPC

Yes, it’s all about debt when the markets believe that to be the case. Giving Greece 2 years to work their problems out when they can’t even figure what the current problem is valued may be a little too optimistic…In the end, something will be worked out.

• Stiglitz: Fears Greece will go bust irrational - Reuters

I agree with Stiglitz. If a large part of the market pounding is speculative, which probably it is, a voice of support from the EU or another body will stabilize markets quickly.

• Rebuilding Greece’s finances – The Economist

Who will bail out Greece? The EU or US (IMF)…interesting read with some great comments.

China

• Red mist – The Economist

Who are the key financial players in China? This article goes through the layers.

• What Asia Can Really Teach America – Time

I will jump to the conclusion. The secret to success in Asia is not big government but what the US stood for, Free Enterprise.

Somewhere in the middle

• On the Brink: Paulson’s Memoir of the Financial Crisis

Looks like this will be an interesting read…Paulson and China…BRICs…

US Politics

• The Secret Memo To Kill Financial Regulatory Reform – The Big Picture

Written by Dr Frank Luntz. Check out http://en.wikipedia.org/wiki/Frank_Luntz …I was wondering where those numbers were coming from…Don’t know who he is working for…

Useful Info on Debt and the European Condition

Global markets continue to face selling pressure as investors fear the worst for European fiscal finances. Almost half the countries in the Euro Area are struggling to recover as jobs fail to be created and liquidity dries up. With the latter point in mind, the fear of a sovereign crisis is building. Leading indicators suggest conditions will keep improving for some countries, i.e. Germany, but that the same is not true counties dependent on domestic demand for growth. In the December Monthly Bulletin released by the European Central Bank, the Bank discussed the pressing need for structural reform in high risk countries to achieve the sustainability of their public finances. On page 90 of the report you will see that 8 of the 16 Euro Area countries are considered to be high risk in 2009 (Ireland, Greece, Spain, Cyprus, Malta, Netherlands, Slovenia and Slovakia) compared to only 3 in 2006 (Greece, Cyprus and Slovenia). The countries with the largest adjustments required to stabilise the debt ratio, based on primary budget positions from 2008-2010, are Ireland and Spain. This does not accurately account for the statistical errors reported in Greece as their fiscal deficit as % of GDP was estimated to be 6% in early October 2009 and by late October it was revised up to 12.5% (page 86).  You may also find it useful to skim through the report for an economic update.

European Central Bank Monthly Bulletin December

The below table of General Government Debt to GDP ratios provided by OECD shows Greece and Italy in the worst state among European countries. The US is not far behind while Japan is in a league of its own.

PDF file: oecd debt gdp

Annex Table 32. General government gross financial liabilities
Per cent of nominal GDP
	2006	2007	2008	2009	2010
Australia	16.1	15.4	14.2	13.4	13.3
Austria	65.9	61.9	62.6	64.8	67.7
Belgium1	91.2	87.6	92.2	92.3	92.1
Canada	68.0	64.1	63.0	65.6	66.9
Czech Republic	34.7	38.4	36.1	35.1	34.8
Denmark	37.4	31.0	28.4	28.5	29.5
Finland	44.8	41.5	39.6	38.8	39.2
France	71.5	70.1	72.5	75.9	79.0
Germany2	69.4	65.5	64.8	66.3	66.3
Greece	105.8	102.3	100.8	99.8	99.1
Hungary	71.9	72.0	71.8	73.6	75.3
Iceland	30.1	24.0	24.8	122.4	126.7
Ireland	28.8	27.9	32.8	40.9	48.4
Italy	117.1	113.2	113.0	114.4	115.9
Japan3	171.9	170.6	173.0	174.1	177.0
Korea	27.6	28.9	32.6	31.5	33.3
Luxembourg	10.4	9.9	18.1	17.3	20.2
Netherlands	54.2	51.7	54.5	54.2	54.7
New Zealand	27.1	25.3	25.3	28.4	32.8
Norway	60.9	57.9	45.4	52.7	57.4
Poland	55.9	52.5	52.8	54.0	55.5
Portugal	72.0	70.1	70.9	72.9	75.1
Slovak Republic	34.7	36.5	38.0	39.0	40.0
Spain	46.6	42.7	44.2	47.7	51.8
Sweden	52.5	47.0	44.6	41.3	40.5
Switzerland	50.6	48.6	48.1	47.5	47.3
United Kingdom	46.0	46.9	58.7	63.6	69.4
United States	61.7	62.9	73.2	78.1	82.5
Euro area	74.7	71.4	70.7	73.2	74.7
Total OECD	76.0	75.0	79.7	82.8	85.8
Source: OECD Economic Outlook 84 database.

Daily Readings: CB Arb report – Geithner?? – Faber’s View – Chanos’ on China – Blackhorse’s Duncan speaks

• THE LIMITS OF CONVERTIBLE ARBITRAGE - TPC
• Has the New York Fed been serving the public trust? Has Geithner? – The Big Picture
• MARC FABER: THE MARKET COULD MOVE SIDEWAYS TO DOWN – TPC
• Chanos’ Parting Shots – CNBC
• Economy will Collapse Without Support – Blackhorse Asset Management Richard Duncan – CNBC

Note: Links to CNBC Squawk Box and CNBC Worldwide Exchange can also be found in Asia News & Markets

Daily Readings: More Chanos – Avoid China HFs – HF Launch Review – CS Bull Story – Asia Inflation and Bubble

• Jim Chanos Talks China – Infectious Greed
• GFIA cuts coverage of China hedge funds – Asian Investor
• The Top Ten Hedge Fund Launches Of 2009 – HedgeCo.net
• CREDIT SUISSE: BUY THE DIPS – THE BEAR ISN’T HERE YET – The Pragmatic Capitalist
• Inflation Risks Rise in Asia – NYT
• 4 Reference Points on China Real Estate – SeekingAlpha – Patrick Chovanec

Caution breeds Inflation

One of the biggest risks with this global recovery is policymakers will keep looking in the rear view mirror for too long. The result will be inflation and bubbles could hit us head on, sapping the life out of the global cycle too soon for economic foundations to be fully restored.  As the world continues to worry about poor job conditions, ballooning fiscal deficits, pending tax hikes and looming NPLs, economic growth keeps surprising on the upside. Strong economic data such as the US PMI, Euro zone PMI and China’s HSBC PMI all suggest the global economy is moving along at a faster pace than many expect. The question, of course, is whether this will continue.

In China, the January HSBC Manufacturing Purchasing Manager’s Index hit 57.4, the highest reading since the survey began in April 2004. Remember not long ago there was a bubble in China and yet the China PMI was a record high. New incoming business in China was the highest since April 2004 with exports increasing at a very rapid pace despite the fact the US economy is recovering without the help of a healthy consumer. It also seems companies in China can’t hire enough to keep up with manufacturing demand and this is all spilling over to a sharp increase in inflationary pressure. That is the bullish story depicted by the HSBC report. In contrast,  China’s Federation of Logistics and Purchasing (CFLP) report actually suggests growth is slowing. However, looking at the latest economic PMI data released in the US and Europe, I would side with the HSBC report.  What this means is China will be forced to raise rates earlier than most expect if the trend continues. They may hike reserve requirements  first but since the ratio is already quite high, I doubt the authorities will be able to use this tactic much longer. Strong growth in China will definitely raise global tensions regarding the Yuan peg as long as Chinese authorities refuse to allow the currency to appreciate. An interest rate hike could defuse some of the tension.

It is easy to still be negative on global growth prospects as unemployment remains high, fiscal deficits soar and now cost-push inflation seems to be heating up. Instead of jumping to conclusions  though, it’s always best to take a step back and reassess. Where are we now when it comes to policy, perception (sentiment/expectations), business cycle and structural conditions? By the end of 2008 to early 2009, the world was awash in liquidity and fiscal stimulus. A year later, government policy remains practically unchanged and companies are in better shape to benefit via increased investment. Meanwhile, policymakers continue to perceive the world to be walking a tightrope to recovery. The risk is they will take their time when it comes to tightening. The business cycle that collapsed in late 2008 is springing back and could do the reverse on the upside. Of  course, we are constantly reminded how structural weaknesses, such as a mountain of bad debt and high unemployment, will constrain the global recovery. These negative factors weigh on sentiment such that analysts and investors will continue to underestimate the strength of past policy decisions. Why? We are talking about a global economy, not just the US or Europe. Ultra easy policy will catapult growth for less debt ridden economies where structural conditions are not an issue, i.e. China and parts of Asia. What I am implying is what if the global recovery continues to gain momentum at a pace far greater than the consensus projects as manufacturers and developers take advantage of easy policy to keep up with future demand?…We are talking about a virtuous cycle…What could also happen is unemployment suddenly starts to turn the corner as companies try to keep up. Policymakers will then be on alert to tighten. Rapidly rising inflation will not hold them back and the fear is they may be too late.  The recent strong PMI figures may just be an anomaly but what if they are a precursor of  growth that will exceed anything recorded the past decade?

Related article

China moves again on lending, economy shows strength

Website redone with new widgets

The past few days, I’ve spent time on the Asia News & Market website so I’ve not been able to get around to writing a post. Since I have no intention of paying for any RSS feed widgets, I had to test whatever free web services were available. I considered putting up flash based widgets but they take too long to load. In the end, what I found was a feed service provided by www.BlastCasta.com which is great for news feed scrolling and feed widgets. Other services I tested were

• yourminis (flash w/ irritating ads)
• FeedWind (too basic)
• www.widgeteasy.com (don’t recommend)
• www.feedostyle.com (nice, but limited and costly)
• FeedSweep (using for Daily News Picks)
• Feed2js (original)
• Grazr (used in the past but slow)
• Springwidgets (used in the past but no longer exists)

That’s about all there is on the web…I added the BlastCasta feed widget (Get Feed) to both the website and this blog and recommend using it for those bloggers interested in having one. The other one on the blog comes with the iNova theme and can not be deleted…Remember javascript doesn’t work with WordPress so simply use the portion of the script from <a href…

Since I started the blog/website in June, both have changed a number of times with the primary intention to improve the blog/website without having to pay for anything. I admit that was not always the case as feeds or widgets didn't work. Hopefully, the ones currently being used on the site hold up from here. Meanwhile, I realize there's plenty to write about be it China, the US or Japan and I will put a few posts up later this week.

Weekend Readings: US Policy? – China future? – The Economy

The past week, Japan was finally warned by the S&P for a fiscal deficit  that’s out of control while Asian markets continued to correct on fears of slower growth in China. However, what really grabbed attention was developments in the US, from Obama’s State of the Union Address, Bernanke’s re-election, Geithner’s AIG grilling and not to forget the strong inventory supported US GDP release. Here are few articles on some of these subjects.

• RUSSELL: HERE COMES THE “SECOND ROUND OF PAIN” – TPC
• Corporate Campaigning – Forbes
• Why Obama’s export push won’t save jobs – Fortune
• China’s Quest for a Shortcut to Greatness – SeekingAlpha -Vitaliy Katsenelson
• Senate, Weakly, Backs New Term for Bernanke – NYT
• March of the Peacocks – NYT – Paul Krugman
• Economy soars 5.7 percent, fastest in 6 years – Reuters

Daily Readings: Gross’s View – HF Startups – India or China – iPad

• THE RING OF FIRE - TPC (Bill Gross’s Feb outlook)
• Excess Supply of Emerging Managers to Come? – HedgeTracker
• India vs. China: Whose Economy Is Better? – Time
• Apple iPad: A Comprehensive Guide – Mashable

Japan: The Best Investment?

When I saw the headlines last week “Japan Is Best Investment Idea for 2010, Wien Says” and Japan back in favour as risk appetite rises, I was a just little surprised…Not by investors in general but by Wien’s view. In early January, I wrote Japan: Still Just a Defensive Trade? and before that Someone May Turn Bullish on Japan in 2010. Sometimes it pays to be a contrarian investor when there are bound to be net buyers of your argument. When it comes to Japan, most investors seem to have walked away refusing to look back. In any case, the sage Byron Wien’s argument goes as follows:

• “Everybody who could sell, sold Japan”
• “Things are getting better.” in Japan
• Lowest returns among major markets last year.

All of those points are true… BofA Merrill Lynch’s January fund manager survey shows:

• 63% expect stronger economy in 2010 for Japan
• net 87% expect better earnings
• Japanese equities are the most undervalued in the world
• 20% would like to overweight Japan

This optimistic take on Japan also coincided with investor sentiment getting a little too bullish.

• 1st time since January 2006, investors are taking above-average risk
• Average cash balances fell to 3.4%, the lowest reading since mid-2007
• net 52% of asset allocators being overweight equities
• net 55% have no protection against a fall in the next three months

Michael Hartnett, Chief Global Strategist at BofA Merrill Lynch was quick to point out “We are, however, seeing early signs that might alert contrarians looking for a selling opportunity.”

I often took these surveys by Merrill Lynch to be the consensus, where many times the lows and highs in sentiment turned out to be reasons to buy or sell. As for Byron’s call, I’m a little disappointed. Japan makes a great defensive trade given it was one of the worst performing markets last year. So far this year, Nikkei has lost -2.7% compared to -8.8% for Shanghai, -4% FTSE and -3.1% S&P 500. However, once the correction is over and fears subside, would investors want to buy Japan? If the story is the global recovery remains intact and policymakers, in China, Europe or US, will not derail the recovery through excessive policy tightening, I somehow doubt Japan will turn out to be one of the best investment ideas for 2010. For now the story sounds OK but when investors reconsider growth prospects be them short-, medium- or long-term, Japan will likely be the least desired compared to Asia or the US. Japanese equities are cheap for a reason…management, or the lack thereof. What will change my view on Japan? One word and that is LEADERSHIP. Both corporate and government leadership that actually understands the predicament Japan faces both present and future and accepts the need to:

• open markets and immigration
• attract foreign capital through less regulation and other means
• adhere to global market principles
• foster a society that accepts the challenges of capitalism realizing growth is derived from profits, innovation and risk management.

Until then, Japan is simply a trade.

On a related note, for the first time in the 12 years of a survey conducted by A.T. Kearney on Best Destinations for Foreign Direct Investment, Japan was not on the list of top 25. In 2007, it was ranked 15th. Chart below: