Whilst many would think market conditions are dictated by economic-data; analyst expectations and investor confidence can have a greater impact than you might think.
Who moves first? Is it the economy or the market? The answer is unclear and there has been huge debate among academics; whilst macro-economic data can help forecast long-term returns the actions of investors aren’t necessarily driven by this. In the short term the investors mood has a greater impact on the market than economics.
Did market movements cause the 2008 crash?
The 2008 financial crisis pointed to the market moving first. S&P 500 lost half of its value between the end of 2007 and the beginning of 2009. US economic growth was -0.3% in 2008 and -2.7% in 2009, where earnings (excluding companies reporting losses) collapsed by 60% over the same period. Yet markets rebounded in March 2009 thanks to help from the Federal Reserve. This was long before the economy started to show signs of recovery.
Did the market anticipate the recovery or indeed cause the crash in the first place? Economic indicators were showing huge weaknesses well before the crisis, so it was only a matter of time before the crash happened. The difference between money market rate and Government rate (a metric of credit stress) was at a multi-year high in 2007, something wasn’t right. With hindsight we can see that this economic data anticipated the market downturn but very few economists had predicted this.
A dynamic relationship
The booms and busts of the world’s economies have always featured this dichotomy between economic data and the markets. Market participants’ expectations and how far these expectations are from reality is what really moves the market through different economic cycles. This in turn increases or decreases appetite among investors.
Many investment banks track how far economist expectations are from the economic data releases and how this can have an impact on investor confidence. Known as surprise indices, these help us to analyse who might be moving first. The Citigroup Economic Surprise Index, for the US, shows an increase in confidence when economist expectations are higher than economic data releases. In August 2008 data showed us that economist predictions were more optimistic than data releases, showing a positive sentiment among economists. A surge in risk aversion after the crash generated an estimates correction in these numbers from within the economist community.
These expectations should be analysed before macro-economic data and the markets. Understanding the interactions between macro-economic conditions, market momentum and investor expectations is key to navigating market cycles. Market participants can be strongly influenced by analysts’ expectations, however, this relationship is constantly evolving so it is crucial that investors are adaptable.
What’s happening today?
The MSCI World index for advanced economies reached a multi-year high in the first half of 2015, before a correction of more than 15% took place at the beginning of this year. Global economic growth is low, but not yet negative. China is decelerating, but still growing faster than any other advanced economies. More specifically, according to the Citigroup Economic Surprise Index for major economies, we are once again seeing numbers that point to an overall optimistic view of the economic conditions, at the same time we are seeing lower expectations on the latest earning releases from large corporates. This coincides with the fact that global earnings are down by approximately 30% from the 2014 peak. Monetary policies, from the likes of the European Central Bank and the Bank of Japan, are likely to help market stability in the short to medium term.
It is key that investors are able to look at global market trends, economic data releases and expectations to inform their investment decisions. At a time of slight market uncertainty individuals need a balanced portfolio that takes both the investor profile and market trends into consideration to ensure returns are maximised.
