- Many investors regard the yield curve, copper, the Baltic Dry Index, stocks and global trade as economic bellwethers.
- After analysing these indicators to actual economic growth, Capital Economics found PMI reports are the best bellwether in terms of predictive accuracy.
- Global trade flows also have a solid relationship to actual economic conditions.
- Both indicators point to a loss of momentum in the global economy in the December quarter.
Signals from the yield curve, Dr Copper, the Baltic Dry Index, stocks and global trade are all regarded as being bellwethers on the health of the global economy.
However, if you’re relying upon these indicators to determine how the economy is performing, you may be doing yourself a disservice.
After analysing a variety of indicators and comparing the results to actual economic growth, Capital Economics says there’s one bellwether that sits above all others in terms of its predictive accuracy: Purchasing Managers Indexes, or PMIs for short.
“In terms of correlations, the PMIs beat all other indicators which are commonly cited as ‘bellwethers’ of the world economy,” Capital Economic says.
“The quarterly averages of both the global composite and global manufacturing PMIs have a correlation of 0.83 with global GDP growth since 1998 when they were first published.
“Furthermore, given that they are released in the first few days of the month after a survey has been conducted, they are very timely.”
PMIs are survey-based indicators that ask businesses about activity levels during a particular month. The responses are then compared to those seen in the past, allowing broader activity levels to be measured in a diffusion index.
A reading above 50 signals that activity levels are improving while a figure below suggests they’re deteriorating. The distance away from 50 indicates how quickly activity levels are expanding or contracting.
This table shows the correlation between the various economic bellwethers compared to quarterly GDP growth.
In terms of their predictive accuracy, PMIs come out on top, edging out East Asian trade volumes by a nose. In particular, the global manufacturing PMI has been the best indicator on economic activity levels.
Capital Economics says composite PMIs — including both manufacturing and services sectors — is a better guide for most individual economies.
So with PMIs and global trade flows regarded as the best indicators for current economic conditions, what have they been signalling for growth in the December quarter?
Perhaps unsurprisingly given the recent volatility in financial markets, the early indications suggest economic momentum has slowed.
“The composite PMI picked up in both October and November, but its average for these months remains below that for Q3,” Capital Economics says.
“The surveys still point to reasonably strong global growth of 3% to 3.5% or so annualised. But even so, they suggest that activity has softened in Q4.”
In terms of trade flows, however, the news is not quite as reassuring.
“World trade volumes are only available for September, but the more timely East Asian trade volumes suggest that momentum slowed sharply at the start of Q4,” Capital Economics says.
“The new export orders component of the global manufacturing PMI, available for November, suggests that demand in the world economy has slowed further too.
“After slower economic growth in Q3, the PMIs and world trade are pointing to a further loss of momentum in the global economy in Q4.”
While PMIs and global trade are good guides to current conditions, Capital Economics warns they are only coincident indicators, providing a signal about the strength of the global economy now, and should not be regarded as leading activity indicators.
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