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How worried should we be about the rollover in lead economic indicators?
As Lex noted earlier this week, Economic Cycle Research Institute has scolded pundits, such as SocGenâ??s Albert Edwards, for misinterpreting its widely followed indices. According to the ECRI all they indicate are a pronounced slowdown, typical after the initial recovery from a recession.
And that is also the view being taken by Citigroupâ??s top equity strategist Robert Buckland, who says the rollover needs to be considered in context.
On many levels, the speed and magnitude of the economic recovery has been remarkable. We have just seen one of the sharpest increases in the US ISM ever. The last time we saw such an emphatic rise in the US purchasing managers index was coming out of the 1982 recession. However, the pace of recovery is beginning to slow. Global purchasing manager surveys are starting to roll over. This should be no surprise given the elevated level of many of these indices. In the US, the ISM has been higher than current levels only 16% of the time since 1948.
As does the fact global equity analysts are putting through more earnings downgrades than upgrades for the first time since the second quarter of last year.
To be sure, rollovers in earnings revisions have preceded major collapses in corporate profits before and should not be taken lightly. Indeed, the fear of a double-dip in corporate earnings is one of the reasons the FTSE 100 is now trading at its lowest level since last September.
However, Buckland reckons this is not a reason to panic this time. As with lead indicators some weakness is only to be expected in the second year of an earnings recovery and none of the factors associated with past collapses in corporate profits are yet evident.
Combining our factors suggests that this is a normal early-cycle rollover rather than an end-cycle warning of impending doom. Yes, earnings revisions have reversed, but they are happening when the yield curve is upward-sloping, inventory levels are relatively low and the global profit cycle is immature. We would be much more worried if revisions were reversing as the yield curve inverted, inventory levels were high and profitability were significantly above long-term averages.
Previous falls in global earnings revisions that turned into something really nasty were associated with at least two of the other factors being in place. During the milder earnings recession of the late 1990s, we had two factors. At the moment, none of our factors are in place to suggest an earnings collapse. This is similar to previous earnings moderations like the mid 1990s. Back then, revisions turned negative but our macro factors suggested a continued recovery. Similarly, in 2004/05, revisions turned negative but we could only check one factor on our list. It was right to assume no earnings collapse
As for Thurdayâ??s â??weakâ?? PMI readings from Asia, the FTâ??s Kevin Brown makes the point on Beyond Brics that there is still growth, just a slower rate.
Growth in Asia's manufacturing sector definitely appears to be slowing, looking at the raft of purchasing managers' indices out today, but the conventional wisdom remains that this is a normalisation after the post-financial crisis surge and not the beginnings of a double-dip downturn.
There is plenty of evidence to suggest that this is right. The numbers themselves (out so far today for China, South Korea and Taiwan, following Japan on Wednesday) all show that positive expansion is continuing, albeit a bit more slowly than in May, which itself was weaker than April.
But as Brown notes, thatâ??s unlikely to be much of a comfort to nervous investors. And thatâ??s certainly being reflected in the performance of the FTSE 100 on Thursday.
Related links: Manufacturing growth slows in Asia â?? FT
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