I’ve made the case in recent articles that the current rally in US equities is not so much a domestic response, but rather a case of global reflation. If that thesis holds water, then weak economic data here in the US is unlikely to derail this rally, but a change in the global outlook most definitely would.
Let’s take a look at where each of those components stands now.
Last Friday the preliminary reading on Q1 GDP was released and it was somewhat disappointing, showing a lackluster 0.7% growth. While initially worrisome, a deeper look suggests that it may be advisable to simply brush off this reading for now.
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At this point you’re probably well aware that first quarter GDP figures have been “off” for some time. The Bureau of Economic Analysis, who compiles this report, has acknowledged deficiencies in their seasonality computations, which leave behind what they call “residual seasonality.”
You can see the effect in the chart below, which shows that during this expansion, Q1 GDP readings have been consistently below that of future quarters. Said differently, Q1 readings always seem to be anomalous.
When you also take into account the fact that average revisions (without regard to sign) between the first and final GDP readings averages 1.1%, you quickly realize how little weight should be placed on these preliminary readings.
Finally, while weak consumer spending is taking most of the blame for the lack of Q1 growth, we actually saw a substantial rise in business spending, which grew at nearly a 10% rate last quarter. This is important because as you can see in the chart below, it has been declines in business investment (NOT consumer spending) that have historically led us into recessions.
The increase in business investment is quite welcome and seems to better reflect the uptick in confidence and sentiment that we’ve seen across a number of polls. If you’re curious how other components impacted first quarter growth, take a look at the chart below.
One of the more obvious items to point out is the effect that declines in inventory had, taking nearly a full percentage point off of GDP. A rebuilding of inventory in future quarters, if we see one, would theoretically add additional growth in the back half of the year.
So the U.S economy, at least based on this latest reading, seems to be about where it has for the last few years. What about the global economy?
Trying to decipher the trend in global growth can be much more difficult than for an individual country. This is because there are many more variables in play. But just as price action in domestic markets reveals truths that are disguised by news and data, so does price action in global indicators.
Up first is the Baltic Dry Index. This index measures the cost of moving major raw materials by sea and is widely viewed as a leading indicator of future economic growth. The general thought process is that the higher the Index, the more demand there is for the movement of goods, and therefore the better the global economy is doing.
As you can see in the chart below, the Baltic Dry Index has risen substantially from its multi-decade low in the beginning of 2016. This is a good sign, and the upward trend appears to remain intact.
Next, let’s take a look at the prices of those raw materials that are being shipped around the world. The CRB commodities index is comprised of 19 commodities. Weighting in the index is roughly 39% energy, 41% agriculture, 7% precious metals and 13% industrial metals.
In the chart below you can see that the commodity complex also bottomed in early 2016 (alongside global equity markets – evident in the subsequent chart), and has been stuck inside a trading range for the past year.
The rebound in commodity prices, led by oil, has helped abate fears of global deflation, but we’re not out of the woods yet. Prices have been sinking back down lately and look poised to retest support at the bottom end of this range. Notice also that the 50-day and 200-day moving averages are declining, and the 50-day just dropped beneath the 200-day, indicating short-term momentum is to the downside.
In my opinion commodity prices are THE place to watch for indications of how global markets are likely to move. I continue to believe that commodities (and oil in particular) must at least remain stable for this rally to continue. If the CRB index breaks out of its range to the downside, I think we’ll see pressure on equity prices around the globe.
Speaking of global equity prices, action in the Global Dow suggests that things are just fine and that conditions may still be improving. The Global Dow (shown below) has been setting consecutive new highs, indicating a worldwide appetite for risk and belief in future growth.
Because US market action is becoming increasingly correlated with global price action, this is a positive development and reflects well on the outlook for domestic equity prices.
I’ll leave you with one last chart (or table, rather) and it shows the latest changes in The Conference Board’s Leading Economic Indexes for the world’s economies. Notice below that the trend is to the upside, with Germany, Japan, and Spain the only countries to see a slowdown in their latest figures.
If this data proves to be accurate (The Conference Board does have a good track record) it suggests that the global economy is still improving and may have some ways to go. And if that’s the case, then just as a rising tide lifts all ships, the US economy (and it’s stock market) are likely to rise with it.
The preceding content was an excerpt from Dow Theory Letters. To receive their daily updates and research, click here to subscribe. Matt is also the Chief Investment Strategist at Model Investing. For more information about algorithmic based portfolio management, click here.
