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.