Even as the vast majority of analysts stayed bullish on the global economy and global risk assets early last year, I began to turn bearish for a variety of reasons, including: 1) global liquidity, as measured by the amount of US$ circulating freely in the global financial system, continued to weaken, 2) valuations in U.S. equities were at the 95th percentile of all readings dating back to the late 1970s, as measured on a P/B and P/E basis, 3) U.S. corporate profit margins were already at 50-year highs, while U.S. corporate profits as a percentage of U.S. GDP was at a high not seen since 1929, 4) U.S. corporate earnings growth, ex. energy, were beginning to decelerate, and 5) our proprietary leading indicator, the CB Capital Global Diffusion Index (“CBGDI”) was indicating a global economic slowdown, as well as a pullback in global equity and oil prices.
I have previously discussed the construction and implication of the CBGDI’s latest readings in many of our weekly newsletters, and last discussed it in this blog on May 15, 2015 (“Leading Indicators Suggest Lower U.S. Treasury Rates“). Specifically, the CBGDI is a global leading indicator which we construct by aggregating and equal-weighting the OECD leading indicators for 29 major countries, including non-OECD members such as China, Brazil, Turkey, India, Indonesia, and Russia. The CBGDI has also historically led the MSCI All-Country World Index and WTI crude oil prices since November 1989, when the Berlin Wall fell. Historically, the rate of change (i.e. the 2nd derivative) of the CBGDI has led WTI crude oil prices by three months with an R-squared of 30%, while leading the MSCI All-Country World Index slightly, with an R-squared of over 40% (naturally as stock prices is typically one component of the OECD leading indicators).
In my May 15, 2015 blog entry, I also stated:
“Our own studies suggest the global economy has been slowing down significantly since the 2nd half of last year [i.e. 2014]; more importantly, the negative momentum has not abated much … the 2nd derivative of the CBGDI has gotten weaker. It also extended its decline below the 1st derivative, which in the past has led to a slowdown or even a major downturn in the global economy, including a downturn in global asset prices.”
The rest is history, as they say.
Recent readings of the CBGDI, however, paint a much brighter picture. Firstly, both the 1st and 2nd derivatives of the CBGDI have stabilized and are now increasing. Secondly, both global equity prices (i.e. the MSCI All-Country World Index) and oil prices have declined to levels that are indicative of a more severe slowdown than the CBGDI readings imply (see Figure 1 below). To me, the latest readings of the CBGDI suggests–at the very least–a stabilization, if not an immediate rally, in both global equity and oil prices.