Macro Weekly – An explosion in September

by: Han de Jong

  • September business confidence indices show an explosion of optimism around the globe.
  • Hard data is following suit
  • Biggest risk is volatility on financial markets
  • Chances of the upturn extending into 2018 are on the rise
171006-Macro-Weekly.pdf (118 KB)

Many commentators have warned that financial markets for risky assets have got ahead of themselves. While the discussion on valuation is always complicated, the general view is that equities, in particular US equities, are expensive and that investors are underestimating the risks. This is thought to be evidenced by the record low level of implied volatility on the (US) equity market, expressed in a VIX-index of below 10. Put into the mix that history hasn’t always been friendly to equity markets in September and October and the advice to ‘head for the hills’ is easily made. An explosion on the equity market could mean a very serious correction. This may happen, who knows? But for now, the only explosion I see is in many economic indicators. And it is an explosion on the positive side.

ISM reaches new cyclical high

Last week, I reported on the uniformly strong regional business confidence indices in the US: The Kansas, Dallas, Richmond and Chicago business confidence indices were all strong. It was therefore not a big surprise that the nationwide index for business confidence in the US, the ISM index, was also strong. Still, the index managed to exceed expectations and actually reached its highest level since 2004. In same gauge for the non-manufacturing sector was at its highest level since 2005. I must admit that the rival PMI indices compiled by Markit are considerably weaker. The thing is that the ISM index for manufacturing has a much, much longer history (going back to the 1940s as far as I can tell) and has an excellent track record over that period.

I mentioned last week that confidence in the eurozone was also exceptionally strong in September, continuing the recent trend, as evidenced by the European Commission’s index of ‘economic sentiment’ reaching its highest level since 2007.

Confidence in China and Japan also strong in September

Recent days also saw September business confidence indices in China released. The national PMI index for the manufacturing sector rose to 52.4, up from 51.7, the highest since 2012, The same index for the non-manufacturing sector reached its highest level since 2014. The September survey data in Japan was equally strong. Whether one looks at the Tankan-survey, the Markit PMI or the official ‘leading indicator’ and ‘coincident indicator’ they all show rising strength in September.


Hard data following suit

In the past, improving confidence indices have not always been matched by the hard data, leading to a discussion which sort of indices are to be believed. The majority view is that the hard data is what counts. I disagree. In my view, the hard data can be problematic because of the usual problems related to data collection and the changing structure of the economy. Confidence data on the other hand, have been collected on a consistent basis for decades and they have a good track record. In addition, the improvement of the confidence indices since some time in 2016 has gradually also come through in hard data. Nevertheless, it remains important to check the hard data, obviously.

The crop of hard data in recent days has also been quite impressive. South Korean exports, for examples were up 35.0% yoy in September, up from 17.4% In August. Sure, there are base effects and the numbers may have been flattered by the movement of the exchange rate of the won (the reported numbers are in USD), but whichever way you look at them, the September numbers are amazingly strong.


US vehicle sales were also very strong in September. Again, we need to bear in mind that August may have been weak due to the hurricanes, but any temporary weakness in August was more than reversed in September.

Last, the most recent set of industrial orders data from Germany, for August, was amazingly strong. True, this data can be very volatile and particularly around the summer. June and particularly July were relatively soft. So the August data be include some positive pay-back. Nevertheless, a mom rise of 3.6% and a yoy increase of 7.8% is impressive. Orders were particularly strong from outside the eurozone. And this is despite the stronger euro. Can you believe it?

What does this all mean?

I must admit that I am impressed with these September data (and August for German orders). What is most impressive is the fact that the unusual strength is showing up wherever you look. All main economies are showing a similar pattern. It could be that this is all just a coincident and that I will be disappointed to tears by the October data in a month’s time. We will have to wait and see. But for now, we must simply conclude that momentum in the global economy continues to build. I am very anxious to see what corporates will say about this during the earnings season that is about to kick off.

Can it be sustained?

If the most recent data is correctly forecasting strengthening economic growth, the question must be if it can be sustained. Is this a last hurrah, soon to be followed by a downturn? As the global economy is currently growing above its potential growth rate, it is safe to forecast that a slowdown will occur. And we even know that a recession is inevitable. The question is when. Remember the old saying that ‘economic recoveries do not die of old age’. Recessions are either caused by a shock, the economy hitting a brick wall or by policy mistakes. Neither of these possible causes look likely to materialise any time soon. Sure, geopolitics and the erratic nature of current US leadership can cause a shock. But a sharp and disruptive rise of oil prices seems unlikely in the near term. Bottlenecks in the economy may occur, but there is no sign whatsoever that inflation is on the rise in a way that would cause a downturn. And while key central banks are set to reduce monetary policy accommodation, they will be eager not to tighten too aggressively. Perhaps the biggest risk to the economic upturn would be sharp corrections on financial markets. The very low volatility as evidenced by the VIX-index cannot last forever and a rise would involve a correction of equity prices. But there is no way of knowing when that may happen or how vicious such a move might be. Corrections happen.

One thing that is needed for a prolonged economic upswing is growing corporate investment. Companies have generally been cautious, preferring to build up cash positions or using the money for share buy-backs. So we need to scrutinise the data for what might happen to corporate investment. The monthly survey among corporates by the Philadelphia Fed includes information about investment intentions. These appear to have strengthened in the last couple of months of 2016 and have continued to strengthen in the course of 2017. They are now at historically unusually high levels. The US data on durable goods orders I commented on last week suggests that actual investment is following suit. If this picture is representative much more widely, this increases the chances that the current global economic upturn can extend itself for some time yet.