A proprietary leading indicator of global growth derived from the OECD’s country leading indices rose in July for the first time since January, consistent with the forecast here of a revival in global industrial momentum from the autumn, allowing for an average three-month lead – see first chart.

An accompanying “leading indicator of the leading indicator”, moreover, rose for a third consecutive month, suggesting that the indicator itself will recover further in August and September – second chart. (The “double-lead” indicator is explained in a previous post.) This, in turn, implies that global firming will extend into year-end.

The basis for the forecast was a rise in global real narrow money expansion in June / July from a bottom in April / May – real money leads industrial output by six months and the leading indicator by three months, on average. The real money measure may have fallen back slightly in August, however, based on early data – third chart. So prospects for early 2013 may be clouding.

The suggested August real money slowdown reflects an upturn in inflation due to recent commodity price strength. Growth prospects for 2013 would be best served by monetary policy-makers stepping off the accelerator to cool commodity markets and contain the inflation drag on real money. Such an argument, of course, is dismissed by Dr Bernanke and his Fed acolytes, and the Bank of England’s target-missers.

A 29,000 fall in claimant-count unemployment in July and August – driven by an increase in numbers leaving the register rather than fewer joining – could be earlier-than-expected evidence of the economic pick-up forecast here to occur during the second half, based on solid real money expansion since late 2011.

The chart shows monthly GDP (derived from data on industrial, services and construction output) together with an indicator designed to estimate the GDP trend based on changes in the claimant count. The last GDP data point for June was depressed by the double bank holiday, with early July evidence suggesting a strong rebound. The indicator, meanwhile, has climbed well above its 2011 temporary peak, suggesting that GDP will reach a new recovery high before the end of 2012. This would entail sequential rises averaging at least 0.6% in the third and fourth quarters.

The Bundesbank’s net TARGET  2 claim on the Eurosystem – its enforced lending to central banks in weaker Eurozone states – rose by a further €24 billion in August to a record €751 billion. Most of the cash flowed to Spain and Italy – the TARGET 2 deficits of Banco de Espana and Banca d’Italia climbed €11 billion and €10 billion, to €434 billion and €313 billion respectively.

The further rise in TARGET 2 imbalances is disappointing, since a recent stabilisation of ECB lending to the banking system – via standard monetary policy operations or as “emergency liquidity assistance” – had suggested a slowdown in capital outflows from the periphery.

In Spain’s case, banks borrowed only €2 billion more during August but were forced to run down their holdings of cash with the central bank by €6 billion.

Italian banks appear to have fared better last month – they repaid €3 billion of borrowing while increasing their central bank cash holdings by €4 billion. Banca d’Italia, however, required extra TARGET 2 funds to offset a whopping €15 billion withdrawal from government accounts at the central bank, probably related to market financing difficulties.

The hope – not unrealistic – is that the ECB’s bond-buying plan together with an improving economic outlook based on earlier monetary policy easing will stem and eventually reverse capital flight from the periphery, allowing TARGET 2 imbalances to subside. Such a development is needed to signal that the current market rally is more than another temporary period of calm before another “crisis” event.

Peter Richardson, in his excellent blog, points out that the S&P large-cap industrials index – comprising the 379 constituents of the S&P 500 index not classified as financial, transportation or utility companies – closed last week at a new record of 1937.31, having surpassed a 27 March 2000 peak of 1917.64. The S&P 500, by contrast, remains 5.9% below a 24 March 2000 high of 1527.46 and 8.1% lower than its all-time peak of 1565.15 reached on 9 October 2007 – see first chart.

An investor who bought the S&P industrials index at its 31 October 2007 secondary peak would now be 5.9% ahead in price terms and 17.6% including reinvested dividends.

UK non-financial stocks have similarly outperformed in recent years, though – unlike the S&P industrials – have yet to reach a new high in 2012. The FTSE non-financials index of 347 companies closed last week at 3625.77, 2.1% above a 29 October 2007 peak of 3549.65 and 6.0% higher than a prior top reached on 10 March 2000. The FTSE all-share index, by contrast, remains 13.1% below its 15 June 2007 high – second chart.

An investor who bought the FT non-financials index at its 2007 peak would now be 22.1% ahead including reinvested dividends.

The collapse of financial stocks associated with the bursting of the Greenspan-Bernanke/Trichet/King credit bubble has depressed the headline equity market indices but will not be repeated. The performance of the non-financial indices in recent years may provide a better guide to the prospective return on an equity market investment over the medium to long run.