Six-month growth of the “global” (i.e. G7 plus E7) real narrow money measure tracked here is estimated to have fallen again in September, confirming July as a peak – see first chart. Allowing for an average nine-month lead, this suggests a slowdown in six-month industrial output growth from around April 2021.

Three-month real narrow money growth, however, stabilised last month and remains above average – second chart. So money trends are still suggesting solid economic prospects for mid 2021.

Cycle analysis also argues against overemphasising recent monetary cooling. As previously discussed, the global stockbuilding or inventory cycle is now in a recovery phase, with a cycle peak unlikely until late 2021 at the earliest. Money-signalled economic slowdowns tend to be minor during stockbuilding cycle upswings. For example, falls in six-month real narrow money growth in 2012-13 and 2016-17 were followed by small and temporary dips in industrial output momentum, with significant weakness delayed until 2014 and 2018 after the stockbuilding cycle had peaked (following lows in late 2012 and early 2016).

Market prospects depend on not the level of (real) money growth but rather any deviation of actual growth from the demand for money based on economic needs. Assessment of current “excess” money conditions is complicated by recent extreme volatility in money and output data.

As previously reported, the gap between six-month growth rates of global real narrow money and industrial output has been informative about future equity returns historically, outperforming both 12-month and three-month growth gaps. A surge in the six-month growth gap from March signalled a V-shaped recovery in markets.

The six-month growth gap appears to have remained positive in September but will turn negative in October, reflecting an output growth base effect from a record 12.9% month-on-month fall in April – see third chart, in which the output projection assumes 0.8% monthly increases in September and October. A negative cross-over would normally suggest shifting defensively, based on the historical risk-return trade-off. The backtesting allowed for a two-month reporting lag, i.e. a negative October gap would suggest cutting equity exposure at end-December.

The negative signal, however, is very likely to prove short-lived. The three-month growth gap, which turned negative in July, is already starting to close as output growth normalises and could turn positive in October just as the six-month gap gives a cautionary signal – fourth chart.

A further consideration is that stockbuilding cycle upswings are usually associated with outperformance of equities and other cyclical assets, albeit punctuated by sometimes significant corrections.

A possible compromise could be to maintain but limit pro-cyclical positioning until the six- and three-month excess money growth gaps return to positive alignment and / or a market correction presents an opportunity to increase exposure at more attractive levels.

Chinese money and credit trends appear to be cooling following a reduction in PBoC policy support, reflected in a significant rise in interbank rates since June.

The consensus interpretation of today’s September numbers is likely to be bullish. Monthly flows of broad credit (total social financing) and bank lending topped expectations, while annual growth of M2 rebounded to 10.9%.

The focus here is on six-month rates of change (seasonally adjusted) of outstanding stocks of money and credit. These peaked over the summer, moderating further in September – see chart.

Growth rates remain well above last year’s lows. The PBoC is probably aiming for stability rather than a slowdown. Business survey evidence of easier credit conditions suggests that lending and money flows will hold up.

The message is that economic momentum may cool from early 2021 but there are no monetary grounds for concern yet. Equally, though, there is no monetary case for additional policy restraint and a further rise in rates.

Most countries have released August industrial output data. The “global” measure tracked here, covering the G7 economies and seven large emerging economies, is estimated to have risen by a further 0.9% on the month, implying that more than 90% of the 18.0% fall between December 2019 and April 2020 has now been retraced – see first chart. An additional increase of 1.7% is needed to regain the peak and is likely to be delivered by October. If so, the round trip in output back to the peak will have occurred four times faster than in the GFC recession / recovery, i.e. in 10 versus 41 months (February 2008-July 2011).

Retail sales had already surpassed the prior peak in June and rose to a new record in August.

Strong growth of industrial output and retail sales over the summer occurred despite a significant rise in G7 plus E7 new covid cases, which have slowed recently as falls in Brazil and India have balanced pick-ups in Europe and the US. The latter are disrupting recoveries in certain service activities but pose little threat to industrial output / goods demand strength.

Equity market earnings are geared to industrial output rather than GDP. A likely return of global output to the peak suggests the same for global earnings per share. The consensus forecast based on bottom-up analyst estimates has recovered but appears to have considerable further upside – second chart.

Does this imply additional strength in equities? Not necessarily. The forward earnings estimate has risen in 238 months since 1988 but the MSCI All-Country World Index in US dollars rose in only 162 of those months, i.e. 68% of cases. There were, in other words, 76 months in which a derating of the market offset a rise in forward earnings.

In 36 of these 76 months, the derating was associated with a rise in real government bond yields. September 2020 was a case in point: equities ended the month lower, despite a rise in forward earnings, as real TIPS yields edged higher – third chart.

A further rise in real yields as global “excess” money is absorbed by economic growth could cap equity market upside despite favourable earnings revisions. Such a scenario offers the best hope of a sector rotation in favour of cyclical value (financials, energy) at the expense of long duration cyclical growth (IT, communication services). September estimates of global narrow and broad money measures will be available later thls week, allowing an updated assessment of current excess money trends.