As often happens in markets, there is a constant battle between the narratives and the economic data.
And more often than not, it’s the narratives that get all the attention as – lets face it – they are more interesting than the boring old data. They also make the news as they tend to be the ones that markets react to in the short term. However, over the medium to longer term, it’s the data that ultimately shapes the final outcomes.
So as investors, we need to understand how both of them affect the asset markets that we are invested in, and the timeframes that apply. The current push-pull between these two is a great example.
The current narratives driving the short term positive sentiments in markets include:
Supporting all this is are the Consumer & Business Confidence measures, that all seem to have bottomed and are hooking up again.
The data that has been coming through has been absolutely supportive of this optimism, and has supported the rising tide of risk assets (stocks, commodities etc) over the past several months. PMIs are in expansion territory again, and retail sales in the US and Australia has recovered to even higher than pre-virus levels off the back of Government payments to individuals. Housing and manufacturing in the US are leading the recovery, which is good as they have the highest employment multiplier effects in the economy. Other growth indicators like industrial production and durable goods orders are still negative year-over-year, but are trending up (i..e accelerating from low levels) and markets like positive rate-of-change in the data, even if the levels are still negative.
The data that we just talked about is in the rear vision mirror. Markets front run the data, such that you will always be behind the eight ball if you wait for published economic data to confirm your position.
This is where forward looking econometric modelling comes in, and there is currently a non-insubstantial risk that as we traverse the 4th quarter this year, the year-over-year data may deliver negative rate-of-change in both the growth and inflation data. This is significant because this particular combination is the economic regime that has historically been associated with “risk off”. It tends to be accompanied with higher volatility, and is usually negative for stocks and commodities, but is positive for bonds and the US dollar. The current trend of high frequency data indicates its a very close call right now between this and the alternative stagflation setup (inflation slightly up), which tends to be better for growth stocks (especially tech) and commodities. The markets have been behaving right in line with this indecision, with weeks of risk off, then flipping to weeks of risk on. Its literally on a knifes edge and the flip flopping in many parts of the global macro markets are reflecting this.
As we write this, the positive narratives are in the ascendency providing a positive market sentiment. Government policy and central bank policy have neutralised / suspended the effect of the big negative problems (such as high unemployment) for now, but will require more Government borrowing and spending (more on this for members in The Big Picture Summary).
The key risk to investment portfolios right now who are heavily weighted in risk assets is if the high frequency growth and inflation data starts to more clearly show a rising probability of the “risk off” deflation regime in Q4. If it does, we’ll provide the update.
Author: Graham Parkes
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