In this article we take a slightly different view on the OECD Composite Leading Indicators to arrive at a conclusion on the outlook for global growth and global equities. The main point of differentiation in our analysis is the application of a breadth framework by constructing a monthly diffusion index across all of the countries the OECD calculates the indicators for. In short, this Diffusion Index measures the proportion of countries seeing monthly expansion/contraction in their OECD CLI. Readings above 50% indicate more countries are seeing expansions (and below 50% more are seeing contractions). So a reading of 100% would mean every country saw an expansion on the month, and a reading of 0% would mean all saw a contraction. The easiest way to understand is by visualizing it on the chart below: e.g. the 2008 financial crisis where the Diffusion Index collapsed to 0% and then rebounded to 100%.
Right, now that we have all that explanation out of the road, it's time to get into the analysis, interpretation, and insights! In terms of the global growth outlook, the Diffusion Index provides a more accentuated and slightly faster view on the cyclical outlook versus the headline "global" index i.e. the OECD +6NME (the 6 non-member economies are Brazil, China, India, Indonesia, Russia, South Africa). At the moment the Diffusion Index has rolled over, whereas the OECD+6NME is still turning up, so it presents a conflicting outlook; thus the next move in the Diffusion Index will be key (e.g. lower readings or readings below 50% will push the outlook to the bearish side).
In terms of the implications for global equities, the Diffusion Index also lines up with changes in equity market cycles. This of course makes some sense in that equity markets are one input into the OECD CLI (but only one input along side other important soft and hard data), but it also makes sense in that it helps define the economic backdrop and hence the predominant direction for earnings growth. In the past when the Diffusion Index has rolled over it has been a reasonably reliable signal to become more defensive, particularly should it pass down through 50%.
So overall, on a global growth and global equity basis, it is signalling that some degree of caution or tempering of the outlook is warranted, but further confirmation is required to build conviction.
After surging in 2016 the Diffusion Index has rolled over and this is something we will be watching closely because if it goes all the way down below 50% that would give cause to become more pessimistic on the global cyclical outlook, whereas a re-acceleration would have the opposite signal.
Aside from impacting on the global growth outlook, the Diffusion Index has a key bearing on the cyclical backdrop for global equities (MSCI ACWI in this case), and a sustained and deeper downturn in the indicator would give cause to become more defensive, at the margin.
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