Macquarie Research, :Unconventional Wisdom --Backward looking markets

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Unconventional Wisdom
Backward looking markets
Event
 Weak data releases in the US have been interpreted as a sign of slower
economic growth ahead.
Impact
 The US data releases say a lot about the past, especially the impact of the
Japanese earthquake, and very little about the future.
 One-off developments have played havoc with the US data for some time and
the assumption that there has been a sudden change of trend in the US
economy is questionable.
 It is far more likely that US growth will show a considerable improvement as
low interest rates and a cheap currency once again exert their power.
Analysis
 Financial markets have a reputation as being forward looking. Yet this
reputation deserves to be examined closely.
 This is particularly the case for the US bond market which is often alleged to
be giving a message about the state of the US economy. Well in October last
year the US 10-year yield dropped to 2.4%, climbed to 3.7% by February
2011 and is now down at 3%. Apparently the US economy was in recession,
then roared and is now weakening again. All in the space of about six months!
 History shows that the first two parts of this trilogy just did not happen. Yet it
was not just the bond market that p
 roved to be misleading. Other indicators also gave false signals.
 A good example was the US leading indicator. Normally this works quite well
as a broad guide to likely trends in US growth. But the acceleration in the twoquarter
growth rate of the leading indicator that started in mid-2010 and
continued into 2011 did not anticipate the slowdown in GDP growth last
quarter.
 This was by no means the first time that there had been a forecasting miss.
Another example was during the Asian crisis of 1997/98 when US growth
defied a downturn in the leading indicator. That period was a warning that
factors outside the US economy can break normal relationships and that
warning should not be forgotten today. For Q1 2011 the key factor was
extremely adverse weather conditions early in the quarter.