Surprisingly-strong UK construction output in October reduces the probability that GDP will post a fourth-quarter decline in payback for a 1.0% surge in the third quarter.

Construction output climbed by 8.3% in October to stand “only” 5.1% below its level a year earlier, compared with a 13.2% annual fall in September. The monthly numbers are not seasonally adjusted but this does not account for the October rise – output fell between September and October in 2011 and 2010.

The chart shows quarterly GDP together with a monthly estimate based on output data for services, industry and construction. The last monthly data point uses published October figures for industry and construction while assuming that services output is unchanged from September (an October number is due for release on 21 December). This generates a monthly GDP reading 0.2% above the third-quarter level.

Previous posts (e.g. here) have demonstrated that global “excess” narrow money growth is predictive of equity market performance relative to cash. There is also evidence that country / regional monetary trends provide useful information for forecasting relative equity market performance.

The first chart shows six-month real narrow money growth rates in major developed economies, with Eurozone countries aggregated into “core” (Germany, France, Benelux and Austria) and “periphery” (Italy, Spain and the “bailout three”). The chart is cut off in June 2012. Switzerland then topped the ranking, with the US and core Euroland joint second, followed by the UK, Japan and peripheral Euroland.

The second chart shows year-to-date equity market performance, currency-adjusted and expressed relative to the World index. Core Euroland is the best performer followed by Switzerland, the US, the UK, Japan and peripheral Euroland. The rank correlation coefficient between performance and mid-year real money growth is 0.92.

The third chart updates the first to show the latest real money growth rates. The US has regained top spot, followed by Switzerland and core Euroland. Japan has overtaken the UK, while peripheral Euroland, though less bad than at mid-year, remains at the bottom of the ranking. This suggests adding US and Japanese equity market exposure, partly at the expense of the UK, while moderating negative bets on the periphery.

The US Institute for Supply Management (ISM) December semi-annual survey of manufacturing and non-manufacturing business signals brighter prospects for capital spending in 2013 while suggesting that spare capacity in the economy is much smaller than conventionally assumed.

The first chart shows the annual rate of change of business investment together with a weighted* average of the capital spending forecasts for manufacturing and non-manufacturing in the December ISM survey of the previous year. The survey has correctly predicted the direction of change of investment momentum in 11 of the last 12 years. The weighted average forecast of 7.1% in 2013 is the strongest since 2007. Based on data for the first three quarters, business investment is on course to rise by about 7% in 2012, down from 8.6% in 2011 but well above the forecast of 0.3% in the December 2011 survey.

The second chart compares the weighted average operating rate reported by ISM firms with the OECD’s estimate of the US “output gap” – the percentage deviation of GDP from “potential”. The operating rate has fallen slightly since the April 2012 survey but remains close to its long-run average, casting strong doubt on the OECD’s claim of a negative output gap of about 4%. US inflation is likely to rise much faster than the Fed expects if it achieves its goal of significant GDP acceleration in 2013.

*Weighted by shares in national income of domestic private industries in 2011.

Chinese money and lending trends continue to suggest stronger economic growth but – thankfully – no return to the credit-fuelled frenzy of 2009-10.

The chart compares six-month changes in industrial output and four measures of real money / lending. The least bullish is real narrow money M1, which was the best of the indicators in signalling economic weakness in 2012. Six-month growth has revived significantly since mid-year but remains modest by historical standards.

The most bullish is real total social financing – a broad credit measure including non-bank trust loans, acceptances and bond financing as well as conventional bank lending. Six-month growth* climbed to an estimated 9.5%, or almost 20% annualised, in November – the strongest since June 2010. The authorities clamped down on credit disintermediation in 2011, resulting in social financing expanding at a similar pace to bank loans. They appear to have reversed course in 2012 in order to stimulate the economy, with a significant growth gap opening up again since the spring.

A scenario of strengthening growth but no boom is supported by the OECD’s Chinese leading indicator, a transformed version of which climbed to a 22-month high in October but remains below half the level reached ahead of the 2009 economic surge.

*A stock series was estimated from flow data and deflated by the consumer price index.

The “monetarist” forecast here that the global industrial cycle would bottom in autumn 2012 and recover into 2013 receives further support from today’s release of OECD leading indicator data for October. As previously discussed, the OECD fails to extract maximum forecasting value from its indicators. The first chart shows a transformed measure covering the G7 and emerging E7 economies. This measure leads industrial output momentum by three months on average and rose for a fourth successive month in October, implying that the incipient global pick-up will extend through January at a minimum.

The second chart shows, additionally, a “leading indicator of the leading indicator”, designed to signal turning points even further in advance – its average lead at peaks and troughs is five months. This fell slightly in October, breaking a run of five consecutive gains and suggesting that a rebound in global industrial growth will peak out around February. The measure, however, is especially sensitive to data revisions and the modest October loss could be revised away.

The bias here is to play down the fall in the double-lead indicator since it is not supported by monetary data. Global six-month real narrow money growth continued to strengthen in October, reaching its highest level since December 2011 – third chart. Real money has an average lead time to industrial output of six months so usually – though not always – turns before the double-lead indicator. A “monetarist” forecast, therefore, is that the global economy will accelerate into next spring, at least.

Importantly, the October increase in the global leading indicator reflects broad-based improvement across countries. Eurozone economic weakness, in particular, should abate, with the regional indicator rising for a third month, consistent with a revival in real narrow money since the spring – fourth chart. The relative optimism about Eurozone prospects held here is also supported by recent firmer survey evidence, including today’s Sentix results for December, which suggest further recoveries in the Ifo and PMI measures – fifth chart.

The global upswing is unlikely to be derailed by US fiscal tightening in 2013, which an eventual budget deal may restrict to 2% of GDP or less. Assuming a Keynesian multiplier of 0.5 (the IMF’s claim to have uncovered a much larger number does not withstand scrutiny), a 2% package would cut US growth by 1 percentage point in 2013 and world expansion* by 0.2 of a point – modest relative to the probable boost from current expansionary monetary conditions.

*IMF measure based on purchasing power parity. US weight in 2011 = 19.1%.