Euroland money numbers for January provide further evidence that the global monetary backdrop was deteriorating before the coronavirus shock.

Six-month growth of real non-financial M1 fell to a 14-month low and has now retraced more than half of its recovery from a low in August 2018 to a peak last October – see first chart.

The recent decline mainly reflects a slowdown in nominal money, although six-month consumer price momentum has edged up since October – second chart.

Incorporation of the Euroland number brings down the estimate of global (i.e. G7 plus E7) six-month real narrow money growth in January to 1.7%, a six-month low – see previous post. The estimate will be firmed up following release of January data for Russia, Mexico, Canada and the UK, as well as final Chinese numbers, on Friday / Monday.

The pick-up in Euroland real money growth in early 2019 was the basis for a forecast that economic momentum would recover in late 2019 / early 2020 – see, for example, here. PMI developments were consistent with the story through January but weak December money numbers prompted a negative reassessment.

The monetary slowdown is likely to reflect the back-up in Euroland market rates during H2 2019 – a market-weighted average of 10-year government bond yields rose by 50 bp between August and December. With much of this move now reversed, money numbers are expected to improve, perhaps as early as this month.

Country level deposit data indicate that the January decline in six-month real narrow money growth was driven by Germany and Spain, with minor recoveries in France and Italy following recent steep falls – third chart.

The MSCI World cyclical sectors index last week briefly reached a new record relative to the companion defensive sectors index, seemingly ignoring a soft global economy and the negative impact of the coronavirus shock. Recent strength, however, has been driven by the IT and communications services sectors – “old economy” cyclical sectors have languished but could outperform over the remainder of 2020 if the “deep V” global economic scenario favoured here plays out.

The coronavirus shock, as previously discussed, has disrupted the normal leading relationship between money trends and economic activity – it has brought forward and magnified economic weakness suggested by a slowdown in global real narrow money since Q3 2019. It has also triggered policy and market responses that will probably result in a monetary rebound. In a benign scenario in which the virus is contained, the combination of catch-up activity and additional monetary stimulus could result in strong economic growth from mid 2020.

Are equity markets already discounting such a scenario? MSCI classifies the 11 GICS sectors as either “cyclical” or “defensive” depending on the strength of their correlation with the OECD’s composite leading indicator index for the OECD area as a whole. The ratio of the World cyclical sectors index to the defensive sectors index, while falling in recent days, remains close to a high reached in February 2018 despite sluggish economic momentum even before virus shock – see first chart. The global manufacturing PMI new orders index, for example, had retraced only 27% of its December 2017-August 2019 decline.

The cyclical sectors are: materials, industrials, consumer discretionary, financials, real estate, communications services and IT. Recent index strength has been driven by the latter two sectors. The second chart shows that the ratio of an index of the “old economy” cyclical sectors to the defensive sectors index is little changed from a year ago and down 9.5% from its 2018 peak, i.e. its behaviour has been more consistent with economic developments, as reflected by PMI new orders, than that of the aggregate cyclical / defensive sectors ratio.

The third chart shows additionally the performance of the tech sectors (IT and communication services) relative to the defensive sectors (consumer staples, health care, utilities and energy). It was necessary to double the chart scale to accommodate tech outperformance. In addition to the strong uptrend since 2015, tech suffered much less damage than the “old economy” cyclical sectors when global activity weakened in 2011, 2016 and 2018.

These observations question MSCI’s classification of the tech sectors as cyclical. The suspicion here is that the historical correlation with the OECD’s composite leading indicator – the basis of the classification – exaggerates the strength of the relationship, reflecting the coincidence of the early 2000s tech bust with the 2001 recession.

Tech sector outperformance has been driven partly by a rerating of valuations; price to book ratios of “old economy” cyclical sectors and defensive sectors are little changed from 2015 – fourth chart.

The suggestion from the above is that investors expecting a “deep V” economic scenario should consider adding exposure to “old economy” cyclical sectors at the expense of not only defensive sectors but also the tech sectors. Tech may be more exposed to near-term economic / market weakness but may deliver less cyclicality than the “old economy” sectors in a subsequent strong rebound.

A post a month ago argued that global monetary developments in early 2020 would be key for assessing economic prospects. A rise in G7 plus E7 six-month real narrow money growth to 3%+ (not annualised) would signal a solid economic recovery. A relapse in real money growth without a prior breach of its September 2019 high, by contrast, would suggest a “double dip”. Available January monetary information supports the latter scenario. The coronavirus shock will accelerate and accentuate weakness but is also triggering policy changes that may energise a H2 economic rebound.

The US, China, Japan, India and Brazil have released January monetary data, together accounting for 70% of the G7 plus E7 aggregate tracked here. Assuming unchanged nominal growth in other countries, and incorporating full CPI data, global six-month real narrow money growth is estimated to have fallen to 1.8%, the lowest since July 2019 and down from a September peak of 2.5% – see first chart.

The January fall was driven by China and the US, with real money growth firmer in Japan, India and Brazil – second chart.

The decline in global real narrow money growth since September suggests that a tepid recovery in economic momentum was on course to roll over in mid 2020. The coronavirus shock has brought forward the reversal, temporarily disrupting the normal leading relationship between money and activity.

As previously discussed, the working assumption here, based on the 911 and SARS shocks, is that the global manufacturing PMI new orders index – a coincident indicator of industrial momentum – will plunge to a low in March / April and rebound into July / August.

The shock is feeding back into monetary prospects. The PBoC has accelerated policy easing and the fall in global bond yields may give early support to narrow money trends even if the Fed and other central banks are slow to act. Commodity price weakness due to the shock, meanwhile, implies a relapse in CPI momentum that will lift real money growth – third chart.

The shock, indeed, may have cut short the real money slowdown, with a rebound possible as early as this month. If correct, the suggested economic scenario for 2020 would be a deep “V”, involving H2 reacceleration as dramatic as near-term weakness.

Chinese money and credit numbers for January were probably little affected by the coronavirus shock, which had limited economic impact until this month. Money trends softened with broad credit growth stable. The results are viewed here as confirming that Chinese economic prospects were weak before the shock.

The first chart shows annual growth rates of the headline money aggregates and preferred alternative measures. Bears have focused on a slump in M1 growth from 4.5% in December to zero but this partly reflected the lunar new year holiday falling in January this year versus February in 2019. The same timing difference last occurred in 2017 – M1 growth fell from 21.4% in December 2016 to 14.5% in January 2017, returning to 21.4% in February.

The distortion arises from China’s definition of M1 as the sum of currency in circulation and demand deposits of enterprises and government organisations, omitting household deposits. Firms pay workers ahead of the holiday, resulting in a fall in their demand deposits and a corresponding rise in those of households. M1 captures only the former. The effect reverses as holiday spending transfers money back from consumers to firms.

The preferred narrow money measure here is “true M1”, which adds household demand deposits to the headline series. The PBoC has yet to release a January number for such deposits but a reasonable assumption is that they matched a 7.8% month-on-month increase in January 2017. On this basis, annual true M1 growth is estimated to have fallen from 6.3% in December to 3.8% in January. (True M1 may also have been affected by the holiday timing difference, though to a lesser extent. Growth fell from 18.9% in December 2016 to 16.4% in January 2017, rebounding to 18.1% in February.)

Growth of the broader M2 aggregate fell from 8.7% in December to 8.4% in January but remains within its narrow 2018-19 range. The relationship between M2 and economic activity has been distorted in recent years by large swings in deposits of non-bank financial institutions. The preferred measure here excludes such deposits: annual growth is estimated to have fallen to a 13-month low of 8.2%, supporting the downbeat message from narrow money.

Broad credit growth was stable in January: the monthly flow of total social financing exceeded the consensus forecast but the annual change in the stock remained at 10.7% – second chart.

The forecast here – before the coronavirus shock – that the global economy would remain weak in H1 2020 rested partly on a judgement that the business investment cycle had yet to reach bottom. Recent news is consistent with this judgement.

The business investment or Juglar cycle (after nineteenth century French economist Clément Juglar) ranges between 7 and 11 years. Cycle lengths are measured between troughs. Lows are marked by a year-on-year contraction in investment. The last G7 trough occurred in Q2 2009 and ended a short cycle (7.25 years) – see first chart. This suggested that the current cycle would be of above-average length – the 11 year maximum would imply a trough in Q2 2020.

Previous posts noted that G7 business investment had slowed but was still rising year-on-year as of Q3 2019. Growth since 2016 had opened up a large gap with stagnant real gross operating profits – second chart. This suggested that investment would weaken into H1 2020 – contrary to a consensus expectation that the US / China trade “truce” would trigger a rebound.

The G7 year-on-year investment change is estimated to have fallen to around zero in Q4 2019, with weakness confirmed by declining industrial output of capital goods – third chart.

The year-on-year investment change also reached zero in Q1 2016, with capital goods output falling. The possibility that the business investment cycle had reached a trough was considered here but rejected because 1) the year-on-year change had not turned negative, 2) the implied cycle length of 6.75 years was outside the 7 to 11 year range and 3) weakness was energy-focused, following the 2014-15 oil price collapse, rather than general.

The year-on-year investment change was expected to turn negative in H1 2020 even before the coronavirus shock, partly reflecting an unfavourable base effect – investment rose by 1.1% between Q4 2018 and Q2 2019. The shock will magnify the fall and may push back the trough to Q2 2020.

What reasons are there to expect business investment to recover in H2 2020, apart from the time limit on weakness implied by the 11 year maximum cycle length? The fall in long-term interest rates since late 2018 is stimulating housing activity and should start to support business investment – which usually responds with a longer lag – later in 2020. Business real narrow money trends, meanwhile, anticipate turning points in the investment cycle and recovered in the US, Japan and Euroland during 2019.

UK GDP grew by a slightly firmer than expected 1.4% in 2019 as a whole but the expenditure breakdown gives little cause for celebration. The increase was consumption-driven, with private investment and net exports flatlining – see table. 

Government consumption grew at the fastest pace since 2005 and was responsible, in an accounting sense, for half of overall GDP growth. Market sector gross value added rose by only 1.1% in 2019, with four-quarter growth falling to 0.6% in Q4.

Business fixed investment increased marginally but remained below its 2017 level. The chart compares trends in the UK and G7 business investment shares of GDP, measured at constant prices, since 2005. UK investment fell more in the 2008-09 recession but the gap had closed by the time of the EU referendum in 2016 (partly reflecting temporary weakness in US energy investment due to the 2014-15 oil price collapse). The UK share has since underperformed by 8%.

Previous posts discussed a simple rule for assessing GDP growth prospects for the coming year, involving comparing December levels of share prices (of domestically-orientated companies) and annual real broad money growth with 12 months before. When both were higher, GDP growth in the following calendar year was usually solid (average = 3.9% in 16 years since 1965). It was usually weak when both were lower (average = 0.3% in 11 years).

The rule gave a negative signal for 2019 but is positive for 2020. The judgement here is that it will prove wrong on this occasion. Share prices – as measured by the FTSE local UK index – recovered from an oversold level in December 2018 but were still lower at end-2019 than in December 2017. The rise in real broad money growth between December 2018 and December 2019, meanwhile, was partly inflation-driven – nominal money growth remains weak and, like share prices, was lower in December 2019 than two years before.