Friday, September 10, 2010

Financial Markets Trading off of Economic Expectations

The start of September has been kind to the equity markets. And if it seems like the last few data economic points have been better than expectations, we’d agree. Housing data has been kinder lately, with the Case Shiller index (8/31) and pending home sales (9/2) breaking a string of very nasty reports during August. The ISM manufacturing numbers were better than expected on (09/01), and the labor market reports have surprised to the upside with the latest non farm payroll (09/03) and initial jobless claims (09/09) beating expectations. This is all good news, though too early to call a definitive end to the slowdown in growth we are experiencing.

Given that the market volatility in August was heavily driven by worries of a double dip, it’s not surprising that the financial markets appear to be breathing a sigh of relief during this bounce off the August lows. The graph below shows how linked financial markets have been this year to changes in economic expectations. The black line on the graph is he SP500 index, and the blue is the Citigroup Economic Surprise Index for the United States. A positive number on the index means economic data points have been beating the consensus expectations and a negative number means they have been come in less than expectations. Currently the line is rising, but it is still in negative territory. The good news is that despite the negative reading, the positive rate of change in the index appears to be driving investors risk appetite at the moment. The risk is that the latest batch data is simply a headfake, and that equity markets are again vulnerable to any weakening in the data from here.