Guest Post by Ned Davis Research
At first glance, the relationship between equities and the economy appears to be highly divergent at this time.
The MSCI ACWI is hovering around all-time highs, while a large second wave of COVID-19 among many of the world’s economies has ravaged peoples’ well-being beyond oblivion.
It’s widely known that markets attempt to predict macroeconomic activity with a lead time. With seemingly effective COVID vaccines now in the early stages of distribution and more fiscal stimulus on the horizon, it’s no surprise that investors are rejoicing over a bright light at the end of the tunnel.
Have markets and the economy really decoupled?
Even so, the economic disconnect some perceive today may not be as large as many think. Aggregate measures of the global economy are holding up, while signs of double-dip recession are scant, if any.
NDR’s Global Recession Probability Model is indicating just a 7% chance of global recession as of February. This is close to its lowest level in over a decade and down from nearly 100% in 2020.
The sweet spot for the model, with respect to global equities, is when it’s falling from the high-risk zone, usually depicting the robust early stages of a bull market. Even so, as also seen in the chart above, the low-risk zone has historically been associated with strong global equity market performance.
Other aggregate measures of global economic activity have remained resilient. The global composite PMI, a monthly proxy for global GDP, held in expansion territory for a sixth straight month in December. Although the index has edged down for two straight months, amid the surge in COVID cases, the index is still above its pre-pandemic level, indicating strong growth.
Additionally, the OECD leading indicator for the global economy rose for an eighth straight month in December to its highest level since before the pandemic.
Economic data is also surprising to the upside by a significant degree, an indication that analysts continue to underestimate the recovery. This suggests that the disconnect between the economy and markets may have more to do with perception. The Citigroup Economic Surprise Index for developed economies is well above its historical norm, while the index for emerging markets is hovering around an all-time high.
Marked by Sharp Divergences
The resiliency of these aggregate readings, however, masks sharp divergences among sectors and countries.
The usually-steady services sector has fallen victim to the second wave of the pandemic. Growth has either decelerated or fallen back into contraction territory among most of the world’s economies. Indeed, our breadth measure of the services PMIs shows that fewer than half of the world’s economies had expanding services sectors in December. Economies that focus more on the COVID-sensitive logistics and hospitality sectors, such as those in southern Europe and some emerging markets, have been particularly sensitive.
Transportation statistics from Apple and Google also indicate limited human engagement. According to calculations from NDR, only 15% of the world’s economies have seen driving routing requests return to pre- COVID levels. Google statistics that track destination show that recreation and retail and transit sites have been the most negatively affected.
These sharp divergences are also evident among countries, and Europe is very likely in the midst of a double-digit recession, as many large economies in the region have temporarily shut down retail shops, bars, and restaurants to help stem the growth of the virus.
China’s economy, on the other hand, is powering ahead, ending 2020 with a year-to-year growth rate of 6.5%. Leading indicators and a low base from last year suggest that annual growth rates may surge to the double-digits in the first half of this year.
Although the U.S. suffers from one of the highest COVID case-loads in the world on a population-adjusted basis, Veneta Dimitrova recently reaffirmed our robust 4.6% growth forecast for 2021, buoyed by the prospect of additional fiscal stimulus.
There are bright spots in the global economy, many of which did not exist during the recession in 2020, supporting the case for economic resiliency.
Global manufacturing has staged a robust V-shaped recovery, with the global PMI reaching its highest level in December since February 2018.
Moreover, contrary to services, the recovery has also been broad-based among countries. Unlike the first lockdowns in 2020, the newest lockdowns have generally left manufacturing business open since the sector is more conducive to social distancing.
The pandemic has also increased demand for manufactured goods, especially many consumer-related goods, such as electronics, home furnishings, appliances, and vehicles.
Global residential real estate has also benefited from the pandemic. Low interest rates, fiscal stimulus (which kept disposable incomes afloat), supply constraints (exacerbated by the pandemic), and work-from-home policies which increased demand for larger homes, have contributed to a pick-up in global housing prices. There’s reason to believe that residential real estate will continue to boom, but it will likely promote more wealth inequality.
Macroeconomic sentiment, especially about the future, has also reached new heights. Indeed, the Sentix Macroeconomic Expectations Index rose to a record high in January. While this might indicate a peak in sentiment, it’s historically not an ominous sign. In fact, expectations tend to top a median of 17 months before recession end, indicating that there’s more to go in this expansion.
But there’s still reason to be jittery about the next few months as the global economy continues to be highly sensitive to COVID developments. The path of the virus as well as the distribution of vaccines and their efficacy, in light of new mutations, could easily present downside risks to the global economy. There’s also the worry that stimulus may be removed too early, especially in China and Europe. In the meantime, however, we at NDR, remain optimistic.
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