Real GDP still has mind of its own

 

We have discussed this before, but the LEI is still at extremely low levels. It may be bouncing off a low and did not reach the critical down 10% YoY, but it has been indicating a major slowdown. The real GDP on the other hand is moving higher. 

The hard landing story is likely over and there may not even be a soft landing. We have seen major divergences between the LEI and GDP in the past. There is no reason, given construction of an index and GDP, that these two should have a percentage connection, but large LEI down moves are associated with a recession. The 2001 period may be similar today but there was a NBER recession. 

Are real rates too high? Does not seem like it

 

10-year real rates have exploded from below zero to over 2%. Some are thinking that this level is too high and requires the Fed to lower rates. Relative to the post-GFC period, the current real rates are well above normal; however, we should place this real rate in context to the more normal period prior to the GFC. 

Of course, is there ever really a normal period? So, what is a normal real rate of interest? Is it close to zero or is it somewhere over 2% and closer to the long-term real rate of growth.  The post-GFC period was dominated by the QE which pushed rates lower, so with QE lowering every month, it is hard to say whether real rates are too high or just returning to normal. 

WEF risk assessment - Points for discussion

 

The WEF Global Risk Report is always a good read highlighting the perceptions by global leaders on what are the greatest risks in the short and long-run. It appears the risk assessments are ripped from the current headlines and are not based on deep thinking; nonetheless, their interconnection map and rankings provide a useful starting point for risk discussion. You may not agree with their risk assessments and presentation, but it does provide context of what is on the minds of major political, business, and thought leaders. 

The number one short-term issue is misinformation or disinformation although it is not exactly clear what that means. If you listen and act on misinformation, there will be clear risks when you find out that what you thought was true is untrue, but what will that lead to? How are economies and societies impacted by misinformation? Clearly, the misinformation of scientific facts are extremely dangerous but there are controls in place to limit risks. There is misinformation of what are verifiable truths, but in this case, the harm can be limited. Is the problem misinterpretation? I find this top risk odd and can be solved through a high degree of skepticism which is good. 

Extreme weather is also an interesting global risk since extremes are often localized. The real weather issue is systemic changes from the norm. Armed conflict only makes it into the top five although the impact can be large and immediate. Most of the biggest macro risks of the last 100 years have been armed conflict. This should always but a top pick. 

The long-term risks are all environmental which also seems odd. These risks are a variation on negative views embedded in Malthusian ideas. In ten years, is it possible that there can be technological changes that can mitigate these risks? Can there be adaptation to these risks? 

Surprising, economic issues of debt and inflation are not front and center in the list albeit in the top ten. Perhaps focused but economics are always a top risk. Solutions to environmental risks and misinformation are always driven by economic impacts and costs.

Purchasing Manager Index (PMI) is not what you think

 

The Purchasing Manager's Index (PMI) has often been considered one of the premier macroeconomic indices on the state of the economy, yet a more exhausting analysis suggests that there is not a strong link between the PMI and equity returns. This goes back to the key issue that the real economy is often not linked with equity returns. Recent work from Citibank reported in the FT discusses the problem. 

The general rule is that the economy is in contraction if the PMI is below 50 and in expansion if it is above 50 for this diffusion index. Further refinements can be made by looking at the 3-month change in the PMI, so there are four states: recovery when the PMI is below 50 and rising, expansion if the PMI is above 50 and rising, contraction if below 50 and falling, and slowdown when the PMI is above 50 but falling. 

The Citibank works suggests that sometimes the PMI indicator works, but it is also the case the equity markets lead PMI. This real indicator based on recent survey information with limited lags does not always provide any early sign on the return and risk in markets.

As usual, working with macro data is messy and there are no clear-cut rules that can be applied to the PMI data. It may tell you something about where you or where you may be going but it is not always a useful map.