A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



Global Economy's Wile E. Coyote Moment

Our prediction last year of a global growth downturn was based on our 20-Country Long Leading Index, which, in 2016, foresaw the synchronized global growth upturn that the consensus only started to recognize around the spring of 2017.

With the synchronized global growth upturn in the rearview mirror, the downturn is no longer a forecast, but is now a fact.

The chart below shows that quarter-over-quarter annualized gross domestic product growth rates in the three largest advanced economies -- the U.S., the euro zone, and Japan -- have turned down. In all three, GDP growth peaked in the second or third quarter of 2017, and fell in the fourth quarter. This is what the start of a synchronized global growth downswing looks like.

Still, the groupthink on the synchronized global growth upturn is so pervasive that nobody seemed to notice that South Korea’s GDP contracted in the fourth quarter of 2017, partly due to the biggest drop in its exports in 33 years. And that news came as the country was in the spotlight as host of the winter Olympics.

Because it’s so export-dependent, South Korea is often a canary in the coal mine of global growth. So, when the Asian nation experiences slower growth -- let alone negative growth -- it’s a yellow flag for the global economy.

The international slowdown is becoming increasingly obvious from the widely followed economic indicators. The most popular U.S. measures seem to present more of a mixed bag. Yet, as we pointed out late last year, the bond market, following the U.S. Short Leading Index, started sniffing out the U.S. slowdown months ago. Specifically, the quality spread -- the difference between the yields on junk bonds and investment-grade corporate bonds -- has been widening for several months.


That happens because the rising default risk for junk bonds during economic slowdowns makes their yields climb faster than those of investment-grade bonds, which are less likely to default. Notably, the yield differential is now close to the widest it’s been since late 2016, when the consensus was much more nervous about the economy.

All of this suggests that the consensus is again playing catch-up on the cyclical outlook, while international central banks, concerned about overheating, are even further behind, and mistaking last year’s synchronized growth upturn for a structural shift toward a “normal” economy. Of course, hawkish shifts in the face of economic slowdowns that policy makers don’t see coming rarely turn out well for the economy.

The current situation is reminiscent of Wile E. Coyote and the Road Runner cartoons. Intent of chasing his nemesis, the coyote almost always misses a sharp turn in the road, running right over a cliff edge. He realizes too late that he’s in midair, and plunges into the chasm below. That’s the crux of the problem for international economies and markets in danger of being blindsided by the cyclical downturn in global growth.

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