Indexes For This Cycle

The Citi Economic Surprise Index is like the CNN Fear and Greed Index in that I usually disagree with its assertions. They are both overly sensitive to changes in the market. I may be biased when reviewing these data points because I always compare the extremes with the financial crisis. For example, in the correction earlier this year, the CNN index showed fear was extreme. When comparing the correction to a bear market, it seems ridiculous to think that’s all the fear that can be in the market. However, I showed in a previous article that the index is a great one to fade based on market performance. This means to buy the market when the index is at extreme fear and sell it when it’s at extreme greed. It’s fair to override that index if you see extreme risk in the market similar to the mortgage crisis. That being said, not many indicators can adequately understand black swan events. It’s unreasonable to expect such accuracy in data points.

In 2008, the market sold off sharply even after it was oversold. For me, beginning investing in 2007 has affected my thinking to the negative side. If you started investing in the late 1990s, you witnessed two massive declines in your trading/investing lifespan; this give you a negative bias. The worry that this bull market will end because cycles are supposed to be 7 years has been powering this bull market for the past 2 years. Bull markets are built on skepticism and bears are built on greed.

Extremely Low Citi Surprise Index In Europe

The Citi Surprise Index simply shows how results are coming in compared to sentiment. It’s the combination of an economic rate of change indicator with a sentiment reading of economists. The current Citi Surprise index for America is 28.2 which is below the recent peak of about 90 in late 2017. You can see how this index appears sensitive because the economy was far from growing at a historically high rate in Q4 2017. That being said, for this current environment, that’s about as fast as the economy can grow. The downside appears more ridiculous as the index was nearly -80 in the summer of 2017 when the economy wasn’t that weak. I predicted it would soon rebound when I was reviewing the index back then.

There are two reasons why I’m discussing the Citi Surprise Index. The first is seen in the chart below. As you can see, the European Citi Surprise index is at -100.1 which is the worst in at least the past 5 years. To be fair, the European economy is seeing a bout of unexpected weakness. It’s far from a recession, but the results are disconcerting. The Stoxx 600 index is up 0.84% year to date. There has been a sharp reversal since late March. I’m surprised to see this rally given the economic weakness. I’ll review the weakness specifically later.

America Is In The Sweet Spot

The chart below is the first time I’ve seen price performance in relation to the Citi Surprise index. This data only goes back to 2003, but at least it includes a bear market to include all situations. America is in the best category for returns as the annualized 6 month returns are 12.38% when the index is in between -50 and 50. The performance is the worst when the index is very high. This worked out well recently as the index was high in late 2017 and there ended up being a correction in February. This index is for America, but if you were to use the European index, there would be 8.12% annualized gains. The bad news is the European economy is weakening and the good news is the estimates are becoming more bearish. Given the lowered expectations, the data would need to fall significantly for this index to fall or stay this low.

German Economic Weakness

The German economy is seeing weakness which isn’t good because it is the biggest economy in Europe. The chart below shows factory orders growth has recently fallen by over half to 3.1%. The consensus was for 5% growth. Furthermore, the month over month growth was -0.9% which missed estimates for -0.2% growth. As you can see, the business confidence was 102.1 which fell from 103.3. To be clear, there have been previous weak data points which were transitory. Since I’m seeing across the board weakness in Europe, I’m more worried about this data than I normally would be.

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To show you that the economic weakness isn’t just isolated to manufacturing and business sentiment, you can see in the chart below that the GDP forecasts for Germany in 2018 have fallen from about 2.5% to about 2.2%. As you can see, the estimates for German GDP growth fell at the exact time the Stoxx 600 rose. That’s probably not a sustainable correlation.

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Italy Is Seeing Weakness As Well

As you can see from the chart below, the Manufacturing PMI in Italy has fallen to 53.5 which is the weakest reading since January 2017. There has been a softening of domestic market conditions. This is the 3rd straight decline in monthly PMI which can’t be blamed on the weather. The global supply side constraints are what is weakening Italian manufacturing output along with American and German output. This was the weakest gain in output in 17 months and the weakest gain in new orders in 18 months. Looking at this data shows you how the American manufacturing weakness is actually less than what other countries are seeing.

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Conclusion

For the time being, I have concluded that the American economy is outperforming Europe because of the tax cuts and regulation cuts. Regardless of the reason for the changes, it’s clear Europe is weakening. The Stoxx 600 is rallying despite these weak reports which is disconcerting. If there is another clear reason America is outperforming Europe, I won’t hesitate to change my mind. I’m not ideological when it comes to investing and analyzing the economy because that causes me to miss out on obvious trend changes.