More on the mean-reverting economic surprise index
A few of the investment banks have a macro or economic surprise index. In March I mentioned Barclays’ version. This month I wanted to highlight Citi’s version and what it is telling us about the US economy.
Here’s the chart:
What I see is weakness that has not yet even reached 2011 proportions but it is telling us that the economic data is largely surprising to the downside. Now in March I wrote:
Barclays Capital has a US Macro Data Surprise Index and it was at all time highs in February. Andy Lees of AML Macro Limited noted in his morning note that it hit that high but has since dipped. He also noted that the 50-day moving average for the index hit an all time high in February as well. I think this is significant for a number of reasons.
First, let’s talk first derivative and second derivative here for a second. We should assume that the surprise index’s hitting highs in February means that the data coming in at that time was the best relative to expectations and so the macro numbers like GDP and corporate earnings should also likely be the best relative to expectations on the back of this. This means that the numbers now coming out are less robust relative to expectations and so the only questions should be whether this trend continues and what impact it has on economic growth, earnings and asset prices. My sense is that we are seeing a reversion to the mean in this index and in corporate earnings. Silver and gold members see my post "2012 an inflection point toward S&P500 margin compression" from a month ago. If I am right, then we will start getting more negative surprises and that will translate into less asset price appreciation over the medium term.
Moreover, if this index has any significance, it would also translate into lower GDP growth in the second half of 2012. I am already expecting this due to the dip in monetary aggregates and the lag in Dow Transports (gold-level post). The question then is whether the recovery in credit and employment growth is enough to spur capital spending by businesses and then even more hiring.
What we have seen since I wrote that post – as told by Citi’s index – is that the surprises have indeed been mostly negative and this has analysts cutting both economic forecasts for the US and their earnings estimates. Moreover, from the chart it is clear that these surprise indices are very correlated to stock and bond markets in terms of judging the risk-on/risk-off sentiment trade-off between asset classes. Unless we see a move in the data toward more positive surprises, expect risk off to prevail over the near term.