A leading indicator of global industrial output growth derived from the OECD’s country leading indices rose further in February, consistent with economic news remaining firm at least through May. As previously discussed, a fall in global real narrow money expansion since November 2011 suggests that output momentum will slow after May. (Real money typically leads by about six months and the indicator by about three months.)

The message that near-term news will remain satisfactory is supported by equity analysts’ earnings forecast revisions, with more estimates currently being upgraded than downgraded. The “revisions ratio” – net upgrades expressed as a proportion of the total number of estimates – correlates with forward-looking business survey activity measures, such as the PMI new orders index.

Within the global measure, a leading indicator for the “E7” large emerging economies remains stronger than its G7 equivalent, suggesting that emerging equities will sustain their year-to-date outperformance of developed markets. The E7 leading indicator also tends to correlate positively with industrial commodity prices.

The prospect of an economic slowdown later in 2012, as suggested by monetary trends, raises the issue of whether investors should position portfolios defensively. The bias here has been to delay such a defensive shift until the monetary warning signal is confirmed by a fall in the leading indicator. Such a strategy would have been “safe” in recent years; indeed, most significant equity market declines were preceded by the indicator turning negative, not just changing direction.

The liquidity backdrop for markets still seems supportive. Annual growth of global real narrow money remains above that of industrial output, a condition that has historically been associated with equities outperforming cash, as documented in previous posts. (Six-month growth rates, however, have crossed, so the annual calculation may give a “sell” signal later this year.) Aggregate bank reserves in the major economies, meanwhile, have risen to a new record, reflecting a recent injection in Japan.