Friday, March 17, 2017

Global outlook improves

It's not just a Trump Bump that is driving stocks higher, nor is it unwarranted or unsubstantiated optimism. Rising equity prices are most likely a response to an improvement in global economic fundamentals that is just now becoming clear. Global industrial production has been rising for the past 6-8 months, and the volume of global trade picked up noticeably toward the end of last year. More recently, today's release of industrial production statistics for February shows a significant pickup in U.S. manufacturing activity in the first two months of this year. All of this was foreshadowed by a pickup in chemical activity which I noted early last summer and which continues to suggest a meaningful improvement in overall industrial production in the months to come.

The market is usually pretty good at sniffing out developments in the economy that are not yet obvious in the stats, and this is the latest example.

Here are some charts that tell the story:

U.S. industrial production statistics have been unimpressive for years, due mainly to wrenching problems in the oil patch. Eurozone industrial production in the Eurozone has been abysmal relative to modest improvement in the U.S., but it has nevertheless been improving, and this improvement become noticeably stronger about six months or so ago.

After several years of almost zero growth, U.S. manufacturing production has jumped, rising at almost a 5% annualized rate since the end of November.

The volume of world trade is a key indicator of global economic health, since expanding trade is an unalloyed good thing: increased trade is arguably the best way to improve a nation's productivity, since it allows trade partners to strongly benefit from the things they do best. In the chart above we see that world trade volumes rose at a relatively tepid 2-3% pace for a number of years, which is consistent with the recent recovery being the least impressive in modern history. But in the second half of last year world trade volume rose at a 4-5% pace. This is very good news.

The Chemical Activity Barometer has done a pretty good job of reflecting—and sometimes leading—overall economic activity in the U.S. Starting last summer this indicator started picking up, and in the year ending February it has increased by over 5%.

The chart above shows that the year over year change in the 3-mo moving average of the Chemical Activity Barometer has been a reliable predictor of improvement in U.S. industrial production. Industrial production is now beginning to improve, as predicted, having increased modestly since last March after several years of decline. More improvement should be on the way.

The chart above shows the CRB Raw Industrials commodity index, which has been rising strongly since late 2015. It's now apparent that this has been driven not by a weaker dollar (as has typically been the case), but by an unexpected and significant improvement in global economic activity. The CRB Metals index (which consists of copper scrap, lead scrap, steel scrap, zinc, and tin) has surged almost 60% since early last year. Very impressive, and it's still ongoing.

So it's not surprising that Eurozone stocks have perked up of late, as has nearly every global equity market. The current equity rally is built on a sound economic base, not on flights of fancy.


William McKibbin said...

Scott's case for an improving economy stands in the face of my counter argument for a declining US economy -- read 'em and weep...

William McKibbin said...

"We can be blind to the obvious, and we are also blind to our blindness." ~ Daniel Kahneman, Nobel Memorial Prize in Economics

Benjamin Cole said...

Nice post, great commentary and charts.

Still, one thing worries me.

Take a look at The Volume of World Trade chart.

Okay, rising like a rocket to 2008, dies, and thereafter rises only slowly. Not quite flatlining, but the good ol' days are over, Rover.

I consider Obama a mediocre President, and Trump still a cipher, although I am hopeful.

But Obama was not President of the world. And global trade is growing very slowly.

David Beckworth, monetary scholar at hard-core right-wing redoubt George Mason, has posited that 70% of global central banking is tied to the Fed. The Fed tightens and so does 70% of the globe's central bankers.

Obama himself could not permanently crimp global trade. Germany can trade with Japan or China and Brazil with Europe as they see fit, even if Obama was not great for the US economy. And, in fact, Obama was something of a "free trader."

Something else is hamstringing global trade. And it predates Trump by eight years.

It was eight years ago that the Fed drove the US into a prolonged recession, and then kept money so tight we never got above 1.7% inflation on the PCE.

Although I am not sure that higher growth would have resulted in much inflation---I suspect easier money would result in more growth, given the amount of global slack that is out there.

The world trade chart seems to suggest a Fed suffocating global growth.