Tian Yang, Variant Perception’s Head of Research, recently covered their must-read Understanding Leading Economic Indicators report with FS Insider. Yang explains the three major categories that most economic data fall into, how leading economic indicators (LEIs) help identify high risk/reward trades, why most economic data in the news is lagging and not helpful for investors and, most importantly, the message coming from LEIs currently on China, Europe, Canada, and the US, especially when it comes to the outlook for inflation.
Here’s a clip of what he had to say on China’s LEIs, which he said are now falling “quite sharply”:
Focus on Leading Economic Indicators
Variant Perception’s leading economic indicator framework helps to solve the problems of out-of-date or yet-to-be revised data, including GDP and inflation data, said Yang. There also tends to be too much averaging of market performance, Yang stated, and analysis based on this technique ultimately ends up producing regression models. These tend to produce results that are more accurate on average, but miss the big turns in the market.
“We want to find data that’s leading, focus on turning points in the leading data, and also focus on the data that’s minimally revised or not revise at all. What we’ve found is the sweet spot tends to be around 6- to 12-month leads, and we’re specifically looking for stuff that has a lead in that period. … The key is capturing the really big turning point moves. And I think that’s where the leading indicators will add a lot of value.”
Markets are too complacent about inflation expectations in the US, Yang stated, partly because of this over-emphasis on central banks targeting lagging data.
If the Fed is trying to target a level in terms of where inflation is headed, they almost necessarily have to build some kind of regression model focused on fine tuning to be correct on average, Yang stated. But, in doing so, they’re ultimately less sensitive around turning points, as Yang believes we are in now.
“Pretty much across the board, all indicators suggest that inflation will see a turning point up and start surprising markets… Obviously, that has huge implications in terms of the Fed’s rate hikes.”
Sources: Bloomberg, Variant Perception, Financial Sense® Wealth Management
LEIs and World Economies
There’s a strong divergence between market expectations for China and what the LEIs are telling us, Yang stated. Variant’s leading indicators for China have turned down sharply, with pretty much all inputs failing, including the slowdown in real money growth, inventory turnover, and signs that global manufacturing has peaked.
As a result, the strength of the renminbi is going to take a hit. In turn, because Europe’s markets are so correlated with China, Yang sees Europe facing difficulties based on the LEIs, as well.
Though other countries may be facing slowing growth and even recession, Yang doesn’t see that in the cards for the US in the next 6 to 12 months.
“Right now, we recognize we’re late in the cycle and momentum could take over. We could get a new high, but given the stage we’re at, it makes a lot more sense to be a bit more disciplined in terms of adding hedges to the portfolio and adjusting the risk-reward ratio.”
To hear this full 38-minute interview with Tian Yang or for a free trial to our FS Insider podcast, click here. For more information about Financial Sense® Wealth Management and our current investment strategies, click here.