Posts here in late 2015 and early 2016 argued for a positive stance on emerging economies and equity markets because 1) narrow money trends in the “E7” large economies had strengthened, signalling a recovery in growth during the first half of 2016, and 2) US money trends, by contrast, had weakened, suggesting reduced upward pressure on US interest rates and the dollar – this was expected to bring relief to China and other countries suffering capital outflows.

E7 economic growth has, indeed, rebounded since end-2015, with money trends suggesting a further pick-up. US / G7 money developments are also now positive. US rates, however, may soon be under renewed upward pressure from firmer economic data and a continued rise in wage growth. This suggests remaining positive on emerging markets but tilting equity market exposure towards “cyclical” markets that benefit disproportionately from stronger global growth while reducing weightings in “interest-rate-sensitive” markets that have correlated positively with US / domestic bond prices historically.

Six-month growth of E7 real (i.e. consumer price-deflated) narrow money began to surge in mid-2015, suggesting stronger economic momentum in spring 2016, allowing for an average nine-month lead. Non-monetary leading indicators confirmed this signal in early 2016. Six-month growth of E7 industrial output rose sharply in May, maintaining a stronger level in June. Real money growth, meanwhile, has risen further, reaching its highest level since 2010 – see first chart.


The increase in E7 real narrow money growth in late 2015 contrasted with a slowdown in the G7, resulting in the E7 / G7 gap turning significantly positive. As noted at the time, emerging equity markets have outperformed developed markets on average historically when the E7 / G7 gap has been positive, underperforming when it has been negative. A rebound in G7 real money growth during the first half of 2016 has narrowed the gap but it remains in favour of emerging equities – second chart.


The rebound in emerging-world economic growth is feeding through to profits. The equity analysts’ earnings revisions ratio  – upgrades minus downgrades expressed as a percentage of the total number of estimates – for constituents of the MSCI emerging markets index has risen to zero, its highest level since 2011. (The average level of the ratio historically has been significantly negative, reflecting analysts’ bias towards over-optimism.) The ratio for the MSCI World developed markets index remains negative but is recovering – third chart.


US economic growth is expected here to speed up significantly in the second half – see previous post. Wage pressures, meanwhile, may increase further. Annual wage growth has tended to rise or fall in recent decades depending on whether the job openings (vacancies) rate has been above or below 3.0% (its average since 1990). The openings rate remains well above this level currently, at 3.8% in June – fourth chart.


The Federal Open Market Committee, therefore, could raise interest rates earlier and by more over the next six to 12 months than markets currently discount. Upward pressure on US rates could boost the dollar and cause capital outflows from emerging markets to pick up again.

The judgement here is that a return to a vicious cycle of capital outflows, currency weakness and equity market underperformance is unlikely because domestic monetary and economic conditions are much more favourable than in 2014-15. A synchronised pick-up in E7 and US economic growth, moreover, could boost commodity prices.

The suggested scenario could favour those markets that have performed better historically when global growth is strengthening (“cyclical” markets) at the expense of those with greater (negative) sensitivity to US / domestic bond yields (“interest-rate-sensitive” markets). Analysis of relative returns since 2005 places Brazil, Hungary, India, Indonesia and Russia in the cyclical grouping, with Chile, Colombia, Malaysia, Philippines and South Africa classified as interest-rate-sensitive. (Other markets have been “averagely” sensitive to the two factors.) Monetary trends, among other considerations, should also be taken into account in assessing the relative attraction of a particular market.

The working assumption here is that the UK economy has slowed sharply but will continue to grow over coming quarters. In assessing the validity of this assumption, particular weight will be given to 1) official vacancies data, which should give an early signal of any contraction, and 2) narrow money trends, which are relevant for assessing spending intentions and prospective activity six to 12 months ahead. July vacancies and money supply numbers will be released on 17 and 30 August respectively.

A default view of continued expansion, rather than stagnation or recession, is adopted because 1) robust monetary trends at mid-year suggest that economic prospects were solid before the Brexit vote shock, 2) global momentum is judged to be strengthening, with positive implications for UK activity via trade and confidence effects, and 3) domestic financial conditions have loosened since the vote – an assumed tightening was a key component of “Project Fear” negative economic scenarios.

The default view is challenged by the plunge in the PMI composite output index in July to a level consistent – according to the index compilers – with economic contraction. Historical evidence, however, suggests that the PMI overreacts to “shocks” – plunges to similar levels occurred in 1998 (Russian default / LTCM crisis), 2001 (New York terrorist attacks) and 2003 (Iraq war) but economic expansion continued. The current level of the output index is less important than whether it stages an early recovery, as it did after the prior shocks – see first chart.

An alternative survey-based measure with a shorter history but a similar correlation with contemporaneous quarterly GDP / GVA* changes is the CBI’s expected growth indicator, based on its polls of services, manufacturing and distribution that feed into the EU Commission’s economic sentiment gauge. The July reading of this indicator was above a level suggestive of economic contraction – second chart.

An important question, therefore, is whether the current divergence of the PMI and CBI indicators will be resolved by the former recovering or the latter sliding further.

The PMI and CBI indicators represent “soft” economic data – they are diffusion indices of “better” versus “worse” responses, rather than measures of the magnitude of economic change. The first significant “hard” (quantitative) data to be released for July will be claimant-count unemployment and vacancies (three-month moving average), due on 17 August. July output numbers will not be available until next month – industrial, construction and services data are scheduled for release on 7, 9 and 30 September respectively.

The vacancies series, in particular, should provide an early warning if the default view here is wrong and the economy is starting to contract. The third chart shows vacancies and claimant-count unemployment over 2008-09. GDP fell from a peak in the first quarter of 2008 to a trough in the second quarter of 2009. Vacancies tracked this decline, moving from a high in February 2008 to a low in May / June 2009.

Claimant-count unemployment is a useful confirming indicator but lags vacancies – businesses can adjust their recruitment plans instantly but take time to shed workers. Unemployment started to rise in April 2008 – one month after vacancies began to fall – and continued to climb until October 2009.

The timely recession signal from the vacancies series in 2008 is further illustrated by the fourth chart. Based on the estimated relationship, a contraction in GDP / GVA would be suggested if vacancies fell by 4% or more over three months. There were 747,000 vacancies in the three months to June, so this implies a decline of 30,000, or 10,000 per month.


The official vacancies series will be the focus of attention here but a monthly fall on this scale is not suggested by the July reading of the Reed job index, a tally of online listings on reed.co.uk, the UK’s largest job board. The fifth chart compares this index, and an earlier online jobs measure compiled by Monster (discontinued in 2012), with the official series**. The Monster / Reed indices have exhibited stronger trend growth, reflecting a structural shift towards online recruitment, but have broadly tracked the official series: the peak and trough months of the Monster index in 2008-09 were the same (February 2008 and June 2009). The Reed index fell slightly between May and June but was little changed in July.

*GVA = gross value added.
**The Monster / Reed indices have been seasonally adjusted.