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Nick Schulz, editor-in-chief of American.com, recently interviewed Cliff Asness, the managing and founding principal of the hedge fund AQR Capital Management. Last year, Asness wrote a provocative piece in the Wall Street Journal about what’s holding the economy back, arguing that “Uncertainty is Not the Problem.” He said: “Many commentators blame our continuing economic woes on ‘uncertainty.’ They allege that recent and anticipated dramatic policy changes make business planning difficult, and that this is retarding growth and employment. This view is not wrong—but our main problem is not the uncertainty surrounding new policies. It is the policies.” Schulz asked Asness to expand on this idea as shown below. Source: The American, March 27, 2012. More on this topic (What's this?) AQR Capital And Other Hedge Funds Shorting Neopost (Value Investing, 3/13/12) Hedge Funds Are Doing Terribly This Year (Crossing Wall Street, 9/10/12) AQR’s Cliff Asness 30 Minute Forbes Interview [VIDEO] (ValueWalk.com, 12/15/12) 
This post is a guest contribution by Joachim Fels of Morgan Stanley. The more things change… A lot has changed in the four months since our last global economic forecast update (see Global Forecast Snapshots: Outlook 2012: Policy Make or Break, November 28, 2011). US policy-makers finally agreed to extend the fiscal stimulus until end-2012. The ECB responded to the euro area debt crisis by flooding the banking system with more than €1 trillion of cheap three-year loans, thus making ‘LTRO’ the most frequently used acronym in investor conversations around the globe. Encouraged by falling inflation and worried about global recession risks, other central banks eased or ‘untightened’ policy in various forms, ranging from more subtle ones like dovish talk (the Fed in particular) and reserve ratio cuts (China, India) to blunter instruments such as rate cuts (ECB, Brazil, Indonesia and several more) and additional outright QE (BoE, BoJ). Encouraged by this second instalment of the ‘Great Global Monetary Easing’ (or GME2), stocks have rallied, risk premia in European peripheral government bond markets have eased, and credit spreads came in. Unsurprisingly, on the back of all of this, investor sentiment has swung from ‘winter depression’ back in November to ‘spring feelings’ now. …the more they stay the same: And still, our baseline scenario for the global economy in 2012-13 has hardly changed since those dark November days. The reason is that we had assumed significant policy responses around the globe to help arrest recession and systemic risks, and policy responses is what we got. However, we were nervous about our base case policy assumptions and thus worried a lot about a much darker bear case scenario where further policy mistakes would plunge the world back into recession. Luckily, these worries haven’t materialised, and to the extent that investors had similar fears, the risk rally simply reflects a collective sigh of relief because ‘bad stuff’ that could have happened didn’t. In short, by coming to the rescue once again, policy-makers, and central banks in particular, cut off the tail risks and helped the world economy to keep stumbling along rather than falling hard. Main scenario remains BBB expansion… Our framework for looking at the world economy remains unchanged: Post-bubble economic expansions are different. Hence, ever since the credit bubble burst and policy-makers came to the rescue to prevent another Great Depression, we have been looking for only a Bumpy, Below-par and Brittle global economic expansion, particularly in the advanced economies. Three years after the Great Recession, strong headwinds to growth continue to emanate from ongoing consumer deleveraging in the US and other former bubble economies, and from banking sector and public sector deleveraging in Europe. The recent rise in oil prices on supply concerns is an additional near-term drag. Partly offsetting these headwinds are tailwinds from ongoing global monetary policy support, which has kept real interest rates in negative territory and asset markets supported, and from generally very healthy non-financial corporate balance sheets. Reflecting these opposing forces, we look for global GDP to grow by 3.7% this year (marginally up from our 3.5% forecast last November) and 4.0% (from 3.9%) in 2013, about in line with the long-term average growth rate, but about 1-1.5 percentage points slower than the previous expansion during the credit boom. …propped up by ongoing policy support: Without ongoing monetary policy support, the BBB global expansion would long have faltered, as it did in the euro area, which is now in recession following ECB tightening last year which aggravated the debt crisis. Looking ahead, we think that the recent and prospective monetary easing will continue to prop up demand and keep global recession risks at bay. On our forecasts, virtually all of the major central banks, and many others, have some more easing in the pipeline this year. During the second quarter of this year, we expect the Fed to extend its Operation Twist and add (sterilised) MBS purchases, the ECB to cut rates one more time, the Bank of England to announce £25 billion additional QE, China to cut official policy rates by 25bp, India to begin embarking on rate cuts, and Brazil to deliver another (final) 75bp rate cut. Many other central banks both in DM and EM will likely follow suit with further easing. Thus, GME2 should continue to reign supreme in the near future. Only later in 2012 and in 2013 do we expect the easing trend to fizzle out and anticipate a few central banks to start undoing some of the easing. This is more likely to occur in EM rather than DM, as we expect EM inflation to trough out at still slightly elevated levels later this year, while DM inflation (provided the oil price roughly follows the futures path as we assume) should ease slightly throughout 2012-13. Continue reading Policy Prop for BBB (Bumpy, Below-par and Brittle) expansion  By Prieur du Plessis, on March 23rd, 2012 posted in: Economy, Global  5 people had their say - chime in!
Like many analysts and economists I have been an avid follower of the Baltic Dry Index (BDI) as a so-called leading indicator of global economic activity. However, I have come to the conclusion that the BDI as such is of no further use to me. The massive growth in demand for commodities from especially China from 2005 to 2008 led to a significant increase in capacity as the number of ships built surged through until the 2010 crisis that resulted in a major change in supply from relatively inelastic to highly elastic. Furthermore, it means that changes in the Baltic Dry Index occur in what is essentially a downtrend or, put differently, in a bear market. However, I have discovered an indicator that is far superior to the BDI. The HARPEX Index was developed by Harper Petersen, a global leading chartering agent. The Index is calculated by using the actual time charter rates for seven classes of ships. This index therefore measures the rates of moving mostly finished goods globally and is an excellent indicator of global consumer activity. Unfortunately the historical data on the website only date back to 2009. (http://www.harperpetersen.com/harpex/harpexVP.do) In the graph below I depicted the HARPEX Index against my GDP-weighted Major Economies Manufacturing PMI as well as the Markit Eurozone PMI, with both the PMIs leading by two months. In the graph it is evident that the HARPEX Index should be rated highly as a coinciding indicator in any economic forecasting model. The value of manufacturing PMIs as leading indicator comes to the fore as it is evident that the GDP-weighted manufacturing PMI of the major economies leads the HARPEX Index by two months. The bottoming and subsequent rise of the PMIs in January this year indicated that the HARPEX Index would rise through end March. It has indeed risen from $376 at the end of February to $393 currently. The slight weakening of the major economies’ PMI in February indicates that freight rates in April are likely to go nowhere and even decline.
Sources: Harper Petersen; CFLP; Li & Fung; Markit; ISM; Plexus Asset Management. The value of the HARPEX Index can be seen in the following graph. During the great financial crisis in 2008/2009 the HARPEX Index fell to $300 and remained relatively unchanged until February 2010. The global manufacturing sector started to expand in August 2009 when the GDP-weighted Major Economies Manufacturing PMI rose above the 50 level in August 2009. It therefore took six months of global expansion to take up the slack in the container shipping industry. Thereafter the PMI and the HARPEX Index moved in the same direction, with the PMI leading by approximately two months.
Sources: Harper Petersen; CFLP; Li & Fung; Markit; ISM; Plexus Asset Management. The current level of the HARPEX Index is indicative of how weak the global manufacturing sector really is. This sector is still in a much better shape than in 2009 as the HARPEX Index is still 30% higher than the presumably $300 absolute minimum level at which ships can operate. In my opinion any further strength in the global manufacturing sector is likely to have an immediate impact on global containerized freight rates as the sector is not recovering from a deep recession as it did in 2009. In a recent article I presented you with a graph of my calculated PMI seasonal factors of the CFLP Manufacturing for China against the Baltic Dry Index, which not only explained the weakness in the BDI but also the shorter-term movements in the BDI. I argued that January/February would also mean a seasonal low for the Baltic Dry Index and a major reversal would be evident in March and April.
Sources: CFLP; Li & Fung; I-Net Bridge; Plexus Asset Management. The BDI subsequently made a low of 647 on 3 February and is currently at 897. Although the BDI is up 38.6% it is still a far cry from what it should normally have been in light of the usually strong seasonal period. It is therefore an indication of the underlying weakness of China’s manufacturing sector. Although I argue that changes in the Baltic Dry Index occur in a bear market due to the underlying fundamental factors, the BDI should not be discarded in total as it does give an indication of the underlying strength of China’s manufacturing sector. I regard the HARPEX Index as a better coincident indicator of global economic activity.
In the video clip below, David Rosenberg of Gluskin Sheff & Associates and Richard Bernstein of Richard Bernstein Advisors discuss whether the American economy has turned a corner and the importance of corporate profits on GDP. Source: CNBC, March 22, 2012. By Prieur du Plessis, on March 23rd, 2012 posted in: Economy, Global 5 people had their say - chime in!
I am writing this post in response to the article “Why Our Recession Call Stands” of March 15, 2012 by Lakshman Achuthan and Anirvan Banerji of the Economic Cycle Research Institute (ECRI). ECRI said: “How about forward-looking indicators? We find that year-over-year growth in ECRI’s Weekly Leading Index (WLI) remains in a cyclical downturn (top line in chart) and, as of early March, is near its worst reading since July 2009. Close observers of this index might be understandably surprised by this persistent weakness, since the WLI’s smoothed annualized growth rate, which is much better known, has turned decidedly less negative in recent months. The unusual divergence between these two measures of growth underscores a widespread seasonal adjustment problem that economists have known about for some time.” The last sentence of the above paragraph must be treated with some circumspection. What they call “the unusual divergence” is in my opinion nothing but a mathematical divergence. Let me take you through their calculation of the smoothed annualized growth rate as I figured it out. ECRI calculates a linear smoothed time-weighted index for every week based on weekly WLI values over the past 52 weeks, where each following week carries proportionately more weight than the previous week. The weekly percentage change of the time-weighted index is then calculated and annualized. My calculation of the WLI smoothed annualized growth rate is virtually a perfect fit of that of ECRI with an r-squared of 0.99.
Sources: ECRI; Plexus Asset Management. It is therefore plain logic that the WLI smoothed annualized growth rate will lead the WLI year-over-year growth rate.
Sources: ECRI; Plexus Asset Management. It follows that even if the smoothed annualized growth rate starts to fall in coming weeks the year-over-year growth rate will start to turn less negative. ECRI also commented that “In spite of the efforts of monetary policy makers, actual U.S. economic growth has slowed, while WLI growth has barely budged from a two-and-a-half-year low.” In previous calls ECRI emphasized the smoothed annualized growth rate of the WLI but its focus has clearly changed to the year-on-year growth rate. Will the improved year-on-year growth rate of the WLI in coming weeks change their mind and cause a big hooray about ECRI‘s change in stance or are they hoping or wishing for a major fall in the markets? It would seem the “unusual divergence” ECRI refers to and its change in focus to year-on-year growth from smoothed annualized growth are used to substantiate their call on the economy, whether it may turn out to be right or wrong. ECRI also said “It is notable that the WLI, which is sensitive to the prices of risk assets that have been supported by massive worldwide liquidity injections, has hardly been swayed from its recessionary trajectory.” In analyzing the WLI I concentrated on three major assets, namely the S&P 500, US 10-year Government Bond Yield and the Economist Metals Index. My analysis indicates that ECRI again focused on year-on-year growth rather than on smoothed annualized growth rates when they made the statement. The U.S. stock indices may have a major impact on the calculation of the WLI. This is evident when the year-on-year growth of the S&P 500 Index is compared to that of the WLI. The growth rate of the S&P 500 Index bottomed at zero percent and is on the rise. This should impact positively on the WLI.
Sources: ECRI; I-Net; Plexus Asset Management. The smoothed annualized growth rate of the S&P 500 Index is clearly exerting upward pressure on the smoothed annualized growth rate of the WLI.
Sources: ECRI; I-Net; Plexus Asset Management. The prices of materials could have a major impact on the WLI and the Economist Metals Index is probably a good proxy for the prices of materials. The year-on-year growth rate of the Metals Index is currently impacting negatively on the year-on-year-growth rate of the WLI.
Sources: ECRI; I-Net; Plexus Asset Management. The smoothed annualized growth rate of the Economist Metals Index is clearly exerting upward pressure on the smoothed annualized growth rate of the WLI.
Sources: ECRI; I-Net; Plexus Asset Management. The U.S. bond market could have a major impact on the WLI and the 10-year Government Bond Yield is probably a good proxy for the U.S. bond market. The year-on-year growth rate of 10-year bond yield index is currently impacting negatively on the year-on-year-growth rate of the WLI.
Sources: ECRI; I-Net; Plexus Asset Management. The smoothed annualized growth rate of the 10-year bond yield is clearly exerting upward pressure on the smoothed annualized growth rate of the WLI.
Sources: ECRI; I-Net; Plexus Asset Management. It would seem that the WLI is in fact currently swayed AWAY “… from its recessionary trajectory” (ECRI’s quote), especially due to the fact that the smoothed annualized growth rates lead year-on-year growth rates. ECRI said: “The unusual divergence between these two measures of growth underscores a widespread seasonal adjustment problem that economists have known about for some time.” I assume the “widespread seasonal adjustment problem” ECRI refers to is the markets’ reaction to the seasonal adjustments that per se influence the WLI. Surely, similar previous reactions or, put differently, price and yield movements due to adjustments, have been taken into account in all the data series and were included in ECRI’s previous calls? I am an investment professional and not an economist and regard the WLI and ECRI’s calls on the economy of great value and indispensable. Whether I agree or disagree with their current recession call is not the point, but I urge them to stick to the original interpretation of their WLI and not to be selective in the interpretation that may be viewed as justifying their view on the economy. After all, markets are extremely well informed and their anticipation of future economic trends is nearly perfect, hence the construction of ECRI’s WLI and the great value it offers to non-economists.
Growth in global economic activity continued to accelerate for the fourth consecutive month in February. Highlights of the February PMIs are as follows:
Note: ISM Non-manufacturing Business Activity Index used instead of Non-manufacturing PMI
Sources: Markit*; Li & Fung**; Kagiso***; Plexus Asset Management****; ISM*****.
Sources: Markit*;.Li & Fung**; Kagiso***; Plexus Asset Management****;.ISM*****.
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