When attempting to determine what the global economy looks like, some economic indicators at an investors disposal may be more useful, while others lag behind.
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Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Thursday, December 22nd at 2 p.m. in London.
At the heart of investment strategy is trying to determine what the global economy will look like and what that could mean to markets. But this question has a catch. Market prices often move well ahead of the economic data, partly because markets are anticipatory and partly because it takes time to collect that economic data, creating lags. When thinking about all the economic indicators that an investor can look at, a consistent question is which of these are most and least useful in divining the future?
One early indicator we think has relatively powerful forecasting properties is the yield curve, specifically the difference between short term and long term government borrowing costs. These differences can tell us quite a bit about what the bond market thinks the economy and monetary policy is going to do in the future, and can move before broader market pricing. One example of this, as we discussed on the program last week, is that an inverted yield curve like we see today tends to mean that the end of Fed rate hikes are less helpful to global stock markets than they would be otherwise.
But at the other end of the spectrum is data on the labor market, which tends to be much more lagging. At first glance, that seems odd. After all, jobs and wages are very important to the economy, why aren't they more effective in forecasting cross-asset returns?
But drill deeper and we think the logic becomes a little bit more clear. As the economy initially weakens, most businesses try to hang on to their workers for as long as possible, since firing people is expensive and disruptive. As such, labor markets often respond later as growth begins to slow down. And the reverse is also true, coming out of a recession corporate confidence is quite low, making companies hesitant to add new workers even as conditions are recovering. Indeed, with hindsight, one of the ironies of market strategy is it's often been best to sell stocks when the labor market is at its strongest, and buy them when the labor market is weakest.
And then there's wages. Wage growth is currently quite high, and there's significant concern that high wage growth will lead to excess inflation, forcing the Federal Reserve to keep raising interest rates aggressively. While that's possible, history actually points in a different direction. In 2001, 2007, and 2019, the peak in U.S. wage growth occurred about the same time that the Federal Reserve was starting to cut interest rates. In other words, by the time that wage growth on a year over year basis hit its zenith, other parts of the economy were already showing signs of slowing, driving a shift towards easier central bank policy.
Investors face a host of economic indicators to follow. Among all of these, we think the yield curve is one of the most useful leading indicators, and labor market data is often some of the most lagging.
Happy holidays from all of us here at Thoughts on the Market. We'll be back in the new year with more new episodes. And thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts, or wherever you listen, and leave us a review. We'd love to hear from you.
