Negative surprises put a cap on the upside potential, especially for equities. As a rule, investors react strongly to surprises, often shaped as economic data. After all, the consensus expectation should already be incorporated in the prices.
It is therefore no coincidence that there are indices that mathematically determine the degree of surprises. A good example are the Citi Economic Surprise indices.
Growth expectations still high
GDP growth expectations remain incomprehensibly high, as we noted in our Monthly Investor Guide published last week. The United States is already in a technical recession - two quarters in a row of negative GDP growth - and yet growth is expected to be 2.4 percent in 2022. That means that even though many growth indicators point in the opposite direction, the US economy should accelerate significantly in the second part of this year.
The outlook for Europe is worse. The energy crisis is taking its toll, and the worst is yet to come as we head into winter. It is true that Europe has started the year better, with positive GDP growth, but how to achieve 2.7 percent for the whole of 2022 is beyond me. The probability of a recession in the Eurozone is close to 100 percent and it seems obvious that by the end of the year we will have started to see it anyway.
Surprise
So there is plenty of room for the Citi Economic Surprise Index to go down further. Based on the past, this should not come as a surprise. During the last two recessions, the Surprise Index fell well below -100. We are currently at -40.
Equity risk
If we are going to get to -100 or worse - which I strongly anticipate - then from the surprise perspective it can be deduced that there is even more downside for equities. In the chart above, the Citi Economic Surprise Index for the G10 countries is plotted against equities worldwide. And although equities are already pricing in more negative surprises, the price trend over the past three months does not point directly to an index reading of -100. In addition, the price development of equities tends to overshoot considerably in the run-up to a recession. So we need to be patient.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His “chart of the week” appears every Monday on Investment Officer Luxembourg.
This article first appeared in Dutch on InvestmentOfficer.nl.
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