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The Savvy Economists Use Multiple Indicators... Here's What They're Showing Today

Joel Litman
         

It’s difficult to quantify how fast economies inflect positively and negatively…

This is why people are constantly chasing new indicators to gauge economic activity… especially in the current environment, where things are changing so quickly and the drivers are so unique.

Some experts have been studying Alphabet’s (GOOGL) Google search trends or different topics. We’ve already seen a correlation between the number of people contracting coronavirus and Google searches for the symptoms of the disease. As such, urban areas with a high volume of searches about symptoms probably aren’t close to reopening or are likely to have to implement restrictions again.

Another unorthodox data source that might be a window into economic recovery comes from Apple (AAPL). The company has been publishing anonymous weekly data on iPhone owners’ activity.

This information shows how many people are walking, driving, and taking public transportation in certain areas, and Apple was able to quantify how travel ground to a standstill during the height of the stay-at-home orders. Now, the data are revealing how many cities are seeing movement pick back up.

Earlier this month, The Economist published a fascinating graphic that shows how pollution levels have trended this year in large cities around the world. This includes New York City, London, Delhi, Paris, and a handful of other large urban areas.

In mid-March, these cities all saw a massive drop in pollution as the quarantine began in and economic activity slowed. Most of the cities’ pollution levels started to rise after reaching troughs in April, but the rise wasn’t consistent across cities… or in its trend of recovery.

Normally, pollution level movements are likely to be more volatile throughout the year, or have specific times of inflection – such as seeing production and therefore pollution slow in big factory cities in China during the Chinese New Year.

Now, the chart can tell us how close things are to being back to normal from the original severity of the drop. This correlation in pollution comes from factory output, overall transportation levels, power plants, and general productivity.

Furthermore, analysts are able to learn from this indicator that while all cities are recovering, some are bouncing back quicker than others.

Paris and Bangalore have only seen emissions come back to 80% and 70% of pre-pandemic levels, respectively. On the other hand, Rome, London, and Delhi are all near or at pre-pandemic levels.

Air pollution is a great example of a lagging indicator of economic activity. If this metric is higher, economic activity has picked up. Additionally, it’s an indicator that investors may want to monitor going forward, as they try to understand how different economies are recovering from the pandemic.

It’s important to distinguish between ‘leading’ and ‘lagging’ indicators…

In any field, leading indicators are datapoints showing that something is “about to happen”… while lagging indicators mean something “has happened.”

In terms of macroeconomics, leading indicators can help predict where the economy is heading. Some examples include building permits, inventory levels, and even the stock market itself.

The market is a leading indicator because it’s focused on future outcomes and cash flows. Investors are attempting to price in potential risks or turnarounds before they occur. Despite being a massive aggregator of data, the market isn’t able to always tell the future… but it gives a good window into where earnings growth and economic activity could be heading.

While some indicators are more consistent than others in terms of accuracy, when used in aggregate, these metrics can help inform where the market is going. That said, leading indicators don’t always paint a complete picture of the economy’s future direction…

Building permits can be canceled, inventory levels shift lower thanks to increased demand, and the stock market in aggregate could completely miss something – like in January and early February this year with the pandemic.

That’s why lagging indicators – such as air pollution levels – are important. Some people tend to shrug these off because they give insight into past trends… but they’re necessary to confirm whether a trend is occurring. Not all of them take quarters to come through – some can quickly tell if something is happening, thus confirming what the lagging indicators signal could be happening.

Other examples of these indicators are inflation, trade balances, and loans outstanding.

For example, the balance of trade measures the net imports of a country minus the net exports. The U.S. has the largest deficit of trade in the entire world, as we import much more than we export. And while the indicator is important, it’s backwards-looking. It only tells us what a country was producing and consuming after it happens.

Many economic indicators in the market are published by both private companies and the government. Some indicators, especially leading ones, have the ability to give “false flags”… so it’s important to build a mosaic that examines multiple leading and lagging indicators in order to obtain a full grasp on the economy.

This is particularly important during a period of significant volatility such as the one we’ve experienced over the past several months… and especially with so much uncertainty in the midst of the recent pullback since early September.

It’s impossible to have total confidence about the future until many leading indicators are pointing in the same direction, so we need to look at them in their totality. Then, it’s necessary to look at multiple lagging indicators for confirmation.

The imperfect record of individual economic indicators is why we at Altimetry never hang our hat on any singular metric when we look at the macroeconomic environment. It’s why each Monday we cover a different indicator to get a gauge on what’s important for economic activity, so we can aggregate them over time and see if things are reasonable during periods of panic or euphoria.

For example, when looking at the credit environment, we’ve studied consumer credit, Commercial and Industrial (C&I) loans, and our aggregate intrinsic credit default swap index. All of them tell us that, while the current pullback is unpleasant, we don’t have to worry about a collapse of credit that could lead to a significant sell-off in the near term.

And similarly, on corporate valuations, we’ve researched inflation, tax rates, and our aggregate Uniform value-to-asset (V/A) metric. Each of these point to signals indicating that while credit doesn’t signal reasons for a massive pullback, valuations have gotten somewhat expensive. This means the pullback is healthy, but also that the market doesn’t need to immediately go higher once we find a base.

Similarly, analytics on management sentiment and corporate profitability signal reasons for confidence about corporate earnings trends. However, this may also be flashing signs that growth – which management teams had been bullish about from May through July – could be slowing. In this case, it would also put a pause on the market moving higher.

Using these and other markers allows investors to take a holistic view. The economy is driven by innumerable factors, so it requires diverse viewpoints to get a complete picture… meaning that it’s vital to always look at multiple indicators.

The current pullback may have some investors concerned. But when we look at the market holistically, it just looks like an opportunity to dollar-cost-average lower. Right now, our variety of indicators can give us confidence that a credit collapse is unlikely… and therefore, so is a sharp bear market sell-off.

Regards,

Joel Litman
September 28, 2020