GROWTH & INFLATION: WHAT NEXT?

Takeaway: We continue to hold a directionally positive outlook for global growth and a dovish outlook for global inflation (TREND duration).

This note was originally published May 20, 2013 at 15:23 in Macro

 GROWTH & INFLATION: WHAT NEXT? - yum

SUMMARY BULLETS:

  • Our proprietary GIP (short for “Growth, Inflation and Policy”) model continues to signal further nirvana for global economy. Specifically, the world is projected to remain in Quad #1 – which is a state denoted by real GDP growth accelerating as CPI decelerates – for the second-straight quarter here in 2Q13E.
  • Incorrectly interpreting YTD commodity price declines – which we have repeatedly identified as a stimulus to the global economy, rather than harbinger of souring economic trends – the bears missed the turn from Quad #3 in 4Q12 to Quad #1 in 1Q13 and we think they are missing the staying power we see at the current juncture as well.
  • A counter-consensus acceleration in global growth is something we think super-sovereign bond markets are starting to focus on. If US Treasuries, German Bunds and JGBs all have one thing in common, it’s that they are allergic to economic growth (review HERE and HERE for more details).
  • Jumping over to our outlook for global inflation, we continue to view the inverse relationship between the USD and the prices of international commodities as a casual factor for the slope of reported inflation readings across the globe (on various lags, due to cross-country variance in CPI basket weightings). That relationship continues to underpin our dovish outlook for global inflation – which is perhaps the most counter-consensus economic call we have [correctly] made all year (review HERE and HERE for more details).
  • We continue to sing the praises of #StrongDollar and the associated leeway incremental commodity deflation is creating for economic growth to surprise to the upside over the intermediate term. Insomuch as #StrongDollar has been a bearish signal for regressive assets like Gold, it has become a bullish signal for pro-growth assets like equities.
  • To that tune, the US Dollar Index holds positive correlations of +0.90 and +0.80 with the S&P 500 and MSCI World Equity Index, respectively, on our immediate-term duration. That contrasts with the -0.86 and -0.61 inverse correlations it holds with Gold and the VIX, respectively, on that same duration. While these statistical relationships are more intense in recent weeks, those directional signals are consistent across the trailing six months of our cross-asset class regression analyses.

THE MODEL

A decade-plus of research and remodeling has helped our macro team develop a predictive tracking algorithm that keeps us 1-2 quarters ahead of the Street on any country or region’s growth and inflation trends. The model isn’t designed with the intent of playing “pin-the-tail-on-the-sell-side-donkey” from a forecasting perspective, but rather designed to proactively signal accelerations, decelerations and inflections in the rates of change (i.e. 2nd derivative) for both growth and inflation. Using the US as an example, the model backtests with an r² of 0.82 for growth and an r² of 0.69 for inflation.

Our macro forecasting model, which is as differentiated as anything you’ll find on the Street, has been [accurately] modeling “countries like companies” for a past ~5 years. As an aside, this practitioner’s approach to macro investing was most recently made popular by Dan Loeb at this year’s SALT conference.

Jumping back into it, our proprietary GIP (short for “Growth, Inflation and Policy”) model continues to signal further nirvana for global economy. Specifically, the world is projected to remain in Quad #1 – which is a state denoted by real GDP growth accelerating as CPI decelerates – for the second-straight quarter here in 2Q13E.

 GROWTH & INFLATION: WHAT NEXT? - dale1

Incorrectly interpreting YTD commodity price declines – which we have repeatedly identified as a stimulus to the global economy, rather than harbinger of souring economic trends – the bears missed the turn from Quad #3 in 4Q12 to Quad #1 in 1Q13 and we think they are missing the staying power we see at the current juncture as well.

 GROWTH & INFLATION: WHAT NEXT? - CRB

THE SEARCH FOR CONFIRMING AND DISCONFIRMING EVIDENCE

At Hedgeye, we don’t think it’s enough to just rest on the conclusions of any model(s); rather, it ultimately pays to vet any research assumptions with confirming and/or disconfirming evidence. In this vein, the evidence continues to affirm the conclusions laid out above.

Looking to global growth, APR PMI data continues to signal positive sequential growth – albeit at a slightly slower rate. Specifically, the median of our 39-index sample of PMI data from all of the key countries and economic blocks was essentially flat MoM, dropping a mere -10bps to 50.8.


 GROWTH & INFLATION: WHAT NEXT? - PMI Scatter

Sequential gains (i.e. positive 1st derivative growth) from larger numbers bodes well for continued acceleration in the YoY real GDP growth figures (i.e. positive 2nd derivate growth), which our model is currently predicting – especially in the context of easier 1Y comps as highlighted in the aforementioned GIP chart and in the chart below. Students of Bayesian statistics understand full well that the base rate is just as important to determining the direction and magnitude of growth figures as the most recent sequential deltas.

 GROWTH & INFLATION: WHAT NEXT? - JPM PMI

A counter-consensus acceleration in global growth is something we think super-sovereign bond markets are starting to focus on. If US Treasuries, German Bunds and JGBs all have one thing in common, it’s that they are allergic to economic growth (review HERE and HERE for more details).

 GROWTH & INFLATION: WHAT NEXT? - 10 2

Jumping over to our outlook for global inflation, we continue to view the inverse relationship between the USD and the prices of international commodities as a casual factor for the slope of reported inflation readings across the globe (on various lags, due to cross-country variance in CPI basket weightings). That relationship continues to underpin our dovish outlook for global inflation – which is perhaps the most counter-consensus economic call we have [correctly] made all year (review HERE and HERE for more details).

 GROWTH & INFLATION: WHAT NEXT? - DXY YoY vs. CRB YoY

 

 GROWTH & INFLATION: WHAT NEXT? - CRB YoY vs. CPI YoY

Our dovish outlook for global inflation continues to be both perpetuated and confirmed by our quantitative risk management signals:

 GROWTH & INFLATION: WHAT NEXT? - DXY

 

 GROWTH & INFLATION: WHAT NEXT? - OIL

 

 GROWTH & INFLATION: WHAT NEXT? - GOLD

THE INVESTMENT CONCLUSIONS

All told, 2013 has been quite a year for top-calling and anchoring on mini-crises of non-epic proportions, which tells us one thing: there are large pockets of the investment community that continue to stare at the tree(s) in lieu of the forest. This is inclusive of this latest global growth scare of the past 4-6 weeks, as indicated by plummeting economic surprise indices.

 GROWTH & INFLATION: WHAT NEXT? - Econ Surprise

That being said, however, we continue to sing the praises of #StrongDollar and the associated leeway incremental commodity deflation is creating for economic growth to surprise to the upside over the intermediate term. Insomuch as #StrongDollar has been a bearish signal for regressive assets like Gold, it has become a bullish signal for pro-growth assets like equities.

 GROWTH & INFLATION: WHAT NEXT? - Oil 3M

To that tune, the US Dollar Index holds positive correlations of +0.90 and +0.80 with the S&P 500 and MSCI World Equity Index, respectively, on our immediate-term duration. That contrasts with the -0.86 and -0.61 inverse correlations it holds with Gold and the VIX, respectively, on that same duration. While these statistical relationships are more intense in recent weeks, those directional signals are consistent across the trailing six months of our cross-asset class regression analyses.

Focus on the forest, not the trees.

Darius Dale

Senior Analyst