Tuesday, 16 April 2013

Who's Got Economic Momentum?

  • For industrial momentum, the ordering is US,  China, Eurozone, Japan
  • For domestic demand, the ordering is US, China & Japan (tied), Eurozone
  • Outliers & Likely Corrections: Industrial and domestic  demand momentum tend eventually to balance. On that basis, expect: i) vulnerability in Eurozone industrial momentum, and ii) recovery of Japanese industrial  momentum.

So which of the world’s major economies has the most positive momentum, and in what way?  I compile momentum indicators for the US, the Eurozone, China and Japan on a monthly basis, making separate indicators for the industrial economy and domestic demand. Where possible, the industrial economy indicator tracks production, exports (both local currency value and volume),  inventory/shipment ratios and capacity utilization.  Where possible, the domestic demand indicator takes in retail sales, auto sale, employment and wages. In both cases, the composition will alter slightly according to the availability of monthly data. For each item of data, I measure the deflection of the month’s data from seasonal trends, and express the result as a number of standard deviations from the average error. Expressing the result as a number of standard deviations allows me to take a simple average of the data I’m measuring.  Finally, I take the 6ma as defining the underlying trend momentum.

Industrial Momentum
Taking the industrial economy first, we can compare the 6m momentum trends. However, at this point, it’s worth emphasising that what’s being measured is changes in momentum relative to each country’s individual experience of the past decade, not absolute performance. Thus US industrial output may be growing by 3.5% yoy whilst China’s is growing by 8.9%, but the underlying momentum change may be (is) more positive in the US.

On that basis, the indicators are pretty unambiguous: the US has the most positive underlying industrial momentum, followed by China, then the Eurozone and lastly Japan.  In absolute terms, both the US and China are gaining momentum, whilst Eurozone and Japan are losing momentum. The leadership of the US is likely to be extended in March’s data, with today’s data showing industrial production up 0.4% mom sa (0.5SDs above trend) and capacity utilization also rising further to 78.5% (1SD above trend). 
Domestic Demand Momentum
For domestic demand, the picture is slightly different, and mostly tells a far more encouraging story. What’s not different is that the US plainly enjoys the most positive domestic demand momentum of these economies, and has does almost continuously since  1Q2011. But since August last year, the improvement in the US momentum trend has found close echoes in both China and (surprisingly) Japan.  

The improvement (relative to their recent experience)  is almost identical for both China and Japan – it is only fractional, but has been sustained now for the past four to five months. 

Finally, the charts confirm the Eurozone as a serious outlier, with domestic demand losing momentum for the past two years with no sign at all of any recovery, hampered by an unemployment rate which has risen almost uninterruptedly from 7.4% at the start of 2008 to 12% now.   Whilst the other major economies  can be seen to have their own cyclical patterns, and can also be seen to respond to other economies’ cyclical fluctuations, there  is no similar pattern in Eurozone domestic demand – rather, we have a continuous erosion of demand momentum. Unlike the rest of  the world, the Eurozone chart suggests Depression not cyclical recession.  

Imbalance and Likely Corrections
Finally, it is worth considering the difference between industrial momentum and domestic demand in each economy, on the basis that over time one would not expect industrial momentum to differ much from domestic demand momentum (and vice versa), in much the same way as one would not expect supply to differ that much, over time, from demand.  Where large deviations between the two occur, we might expect a tendency for them to reconnect – for example, if industrial momentum was sharply more positive than domestic demand, we might expect either industrial momentum to slow, or domestic demand momentum to accelerate.

The following chart, then, simply looks at 6m industrial momentum minus 6m domestic demand momentum. Where the line is positive,  industrial momentum is greater than domestic demand; where negative industrial momentum is not keeping up with domestic demand momentum.  The first thing to notice is that both the US and China are roughly balanced.  Second, for the last three years Eurozone industrial demand has run persistently stronger than domestic demand momentum (even though since 2008, the difference has averaged zero).  One would continue to expect either industrial momentum or domestic demand  momentum to change trend  in order to resolve this disequilibrium.  Personally, I think this suggests latent vulnerability in Eurozone industrial momentum.  Third, in Japan domestic demand momentum has survived better than industrial momentum over the last year. Japanese consumer confidence indicators tells that no abrupt collapse in domestic demand is anticipated: if so, these are grounds for expecting an upturn in Japanes industrial momentum in the short to medium term.  

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