Indicators To Track Economic and Financial Recovery
Discussing key financial, economic, and industrial metrics
With the COVID-19 outbreak forcing a global economic closure, major countries have experienced lows in economic output, business and consumer sentiment, and industry activity. Many countries have seen their curves flatline, and signs have duly pointed to the start of a slow recovery. However, the US continues to see high case numbers, and consumer confidence in the economy remains low. Recovery will likely vary by industry, with some predicted to witness a V-shaped revival and others experiencing fluctuations before returning to pre-COVID levels.
The pandemic and the ensuing economic downturn have also led to volatility in the stock market, as investors experienced high negative sentiment in March, coinciding with the onset of the US shelter-in-place orders. However, like with some economic indicators, the market later displayed positive signs and a bullish recovery.
As seen below, America’s GDP suffered the greatest quarterly contraction (32.9%) in Q2 2020, a much sharper drop than that of 2008’s Great Recession. With businesses closing and people forced to stay at home, consumer spending, exports, and private inventory investment (key components of GDP) all declined. The Fed projects an overall -6.5% shrink in real GDP in 2020, as well as 5% growth in 2021, 3.5% growth in 2022, and 1.8% growth in the longer run (defined to be 5–6 years).
I present below a few key indicators that we can use to track economic and financial health, specifically business, consumer, and investor sentiment metrics. I will also discuss certain industries’ recovery and potential macroeconomic scenarios for further perspective on current economic health and confidence.
Macroeconomic Indicators:
We can forecast economic growth or decline using the simple process of predicting business and consumer sentiment. Ultimately, firms and consumers are the two most integral parts of an economy, and thus we do not need to overcomplicate our predictions by introducing other variables.
While GDP is perhaps the most commonly used macroeconomic indicator, it is a measurement for the previous quarter or year. Thus, it is better for examining the economy’s impact on past industry and stock market performance, rather than future market shifts. We will use GDP as a basis to examine our indicators’ predictive power.
The main metric for business sentiment is the PMI (Purchasing Managers’ Index), an economic confidence indicator computed after surveying managers of leading companies that focus on a diverse array of industries. The US PMI is released monthly by the Institute of Supply Management (ISM) in their Report on Business. Like with most other countries’ PMIs, the US ISM PMI uses 50 as the benchmark, representing an expectation of zero growth. A reading greater than 50 indicates positive growth, while one less than 50 indicates negative growth.
ISM surveys more than 800 American executives on topics including production changes, imports, employment, prices, commodities, etc. Additionally, ISM releases two types of PMIs: manufacturing and non-manufacturing. Generally, we want to focus on the Manufacturing PMI, as it is more unpredictable than its more cyclical Non-Manufacturing counterpart.
As seen below, the US ISM PMI and GDP Growth Rate have shown very similar patterns over the last 25 years. The PMI hugs the GDP Growth Rate, especially during the 2008 Subprime Mortgage and Wall Street Crisis leading to the Great Recession, proving its strong predictive power. Note that PMI is a monthly indicator, whereas GDP Growth Rate is measured quarterly (latest values excluded for scalability purposes).
Below, we see PMI for the last 365 days. The July reading of 54.2 indicates a sharp rebound from the April low of 45.1, continuing to show positive business sentiment after June’s reading of 52.6. This reading is also the highest since March 2019.
With American consumer sentiment also having tremendous influence over the global economy, we also want to forecast consumer sentiment. We use the University of Michigan’s Survey of Consumers Index, which is based on a minimum of 500 telephone surveys. The surveys range over three main topics: personal finance, business health, and buying conditions, in both the short and long run. The survey’s scale ranges from 40 to 120, with a reading of 80 being the benchmark.
Like with PMI, the Survey of Consumers’ Index also shows very similar patterns when compared to GDP Growth Rate (though to a lesser degree). Nevertheless, the metric has strong predictive power and should be incorporated in our analysis (latest values excluded for scalability purposes).
Unlike PMI, however, Consumer Sentiment dropped in July from 78.1 to 72.5 due to the upturn in coronavirus cases. Consumer sentiment may stay low for the next few months as the pandemic and governmental restrictions continue.
For more information on these macroeconomic indicators, read this article by Concoda, an established Medium author who writes on key economic and financial issues and trends.
Financial Indicators:
With the stock market being a real-time reflection of investors’ view of economic and business strength in the near future, we should also monitor investor sentiment. Economic growth translates into higher company earnings, and thus, higher stock prices and dividends for shareholders; economic contraction has the opposite effect. Along with managers and consumers, investor behavior can be very insightful when it comes to economic expectations.
One stock market indicator worth monitoring is the CBOE Volatility Index (VIX), also known as the “Fear Index,” a market index portraying 30-day forward-looking volatility. VIX is derived from S&P 500 price inputs, and with the US comprising over 50% of the global market and the S&P 500 making up 85% of the US market, VIX proves a great indicator for research and predictions.
Unlike our other indicators, a downward shift in VIX indicates positive investor sentiment (as fear is low). In contrast, spikes in VIX signify a declining market.
As seen below, VIX (shown in blue) saw a significant rise in March before falling drastically in the same month. It has since been on a downtrend aside from a moderate rise in early June, as well as being consistently below its moving average (shown in yellow), one of the most commonly used technical analysis metrics, indicating positive investor sentiment, showing strong positive investor sentiment.
Additionally, we want to monitor the currency pair of the Swedish Krona and the Japanese Yen (the SEK/JPY pair). Sweden is home to many cyclical industries, such as iron, steel, and petrochemicals, causing investors to pull money out of the Krona during times of economic contraction. On the other hand, the Yen experiences inflows during these times, as its relative lack of inflation makes it an attractive currency for borrowers.
Looking at key economic events (the 2008 Subprime Mortgage and Wall Street Crisis, the US-China Trade War, etc), the SEK/JPY pair does move with economic sentiment, proving its efficacy as a market indicator.
The currency pair has declined overall in the past year, but lately investors have turned to the Swedish Krona, leading the pair to rebound from its March lows. It is also currently outperforming its moving average, and at the time of writing, is at its highest in the last 365 days.
We also want to track High Yield Debt, or high-risk corporate bonds (securities issued by firms to investors for raising capital) that investors would like to keep during economic growth, but be quick to discard during downturns. Blackrock, the world’s largest asset management firm, and Barclays, the UK’s second largest investment bank, both have corporate bond exchange traded funds (funds which track an index of securities) that we can monitor. They are denoted by the tickers HYG and JNK respectively.
Below is ticker HYG for the past two years. The bonds saw heavy lows in March but quickly rebounded in April and have seen a general strong positive trend since, signifying positive sentiment.
Another more easily interpretable (yet still informative) investment sentiment is the CNN Fear and Greed Index. CNN utilizes market volatility (as seen with VIX), safe-haven demand (SEK/JPY pair), and junk bond demand (HYG and JNK), among other factors, to calculate their index. The index allows us to observe the general bullish or bearish trend of the market as well as extremities in investor psychology.
Like our other indicators, the Fear and Greed Index saw a dramatic low around March before a steady rebound. The Index is at 72 at the time of writing, indicating relatively strong greed.
For more information on these metrics and market shifts, check out this article by Concoda.
Industrial Metrics and Macroeconomic Scenarios:
Along with our general economic and investor indicators, we want to track the revival of certain industries to give us a more complete picture of the country’s economic recovery.
Bloomberg presents quite an informative tracker called the Bloomberg Economics Recovery Tracker, which utilizes alternative (data published about a company or industry from outside sources) and market-based data to provide insights into the spread of the virus, performance of key industries, and health of financial markets.
Below is the Recovery Tracker chronicling the virus’ spread from its onset until August 7th. Financial markets remain quite healthy, and mortgage applications and consumer comfort continue to improve. Public transportation, airlines and restaurant bookings are on a slow path to v-shaped recoveries. Nevertheless, unemployment remains high despite reaching pandemic lows, as applications for unemployment insurance stay at over 1.2 million per week.
Additionally, McKinsey’s report on COVID-19’s Implications for Business and their weekly briefing notes are another great source to examine how firms and industries can react to the ongoing pandemic and governmental policy changes. Their note on August 13th explains how leisure travel is recovering faster than corporate travel, as it has in the US and other major countries in past economic downturns. Additionally, with the pandemic expediting automation in business operations, consumer sales managers must upgrade their employees’ skillset to make them more accessible to both consumers and manufacturers.
Below are five scenarios on the recovery of real GDP, in order of likelihood, resulting from surveys of global executives on the speed of economic recovery. In the most popular scenario (33% of total respondents according to the June survey), the virus resurges intermittently despite an overall effective response, meaning the world economy rebounds to pre-pandemic levels in late 2022, while the US economy fully recovers in three years. On the other hand, the grimmest scenario (12% of total respondents) has the virus recurring over multiple years, leading to slow long term growth and prolonging America’s recovery to after 2025.
Conclusion:
Overall, financial markets and investor sentiment have rebounded from their March lows, while US business sentiment has also improved. However, American consumer sentiment remains low and unemployment claims high amid rising numbers in cases. Industries are expectedly a mixed bag, with housing remaining strong but air traffic and restaurants, among others, still struggling.
A sizable portion of the global executives surveyed by McKinsey (around 35%) predicts that the world and US economies will rebound within the next year (scenarios A3 and B1), whereas the Fed projects that the US economy will return to pre-pandemic output levels by 2022. With improvements in business sentiment and certain industries reviving quickly, we can find reasons to be optimistic despite the continued spread of COVID-19. Time will tell if governmental actions, such as future stimulus packages, will help consumer confidence along with business and investor sentiment. However, returning to closures could severely hurt both economic and financial health and further prolong the crisis.
