(Bloomberg View) -- The U.S. economy appears to have hit its stride in recent quarters, with above-trend growth fueled by strong domestic demand. That hasn’t kept skeptics from expressing their doubts. After all, forecasting is about weighing a range of outcomes and then picking your battles with the consensus. Yet, many of the arguments advanced by the growth bears are mostly wrong or misleading. Let’s take a look at three that have popped up recently.
Early in 2017, consumer and business confidence -- so-called soft measures of economic activity -- were riding high, but hard measures such as retail sales and core durables were sluggish. If activity was not picking up, there was reason to be skeptical of the improvement in confidence, or so the thinking went. With the benefit of hindsight, we know there was little reason to fret. U.S. domestic demand is growing at the fastest pace in three years, so the hard data has, for all intents and purposes, caught up to the soft data.
The broader point is that there is good reason to pay attention to survey-based measures of economic activity, which tend to improve the accuracy of a forecast in real time. Hard measures tend to be volatile, while survey measures tend to be less so and are released on a timelier basis. Consumers and companies don’t say economic conditions are good for no reason. Gaps between hard data and soft data don’t last for long, and they usually break in favor of the soft data. Today, survey measures of activity point to solid growth.
A recent talking point goes like this: U.S. data has been too strong relative to consensus for too long. That means the reports are likely to disappoint, creating a headache for markets. The primary flaw with this kind of analysis is that it makes inconsistent assumptions about the market’s forward-looking behavior. Economic surprises are mean reverting. If investors know this, won’t the decline in the index already be priced in when the index is high? Like corporate earnings releases, economic information is priced in upon announcement. It is hard to see why markets would want data that have already been released.
A trading strategy that uses a surprise index will go short the equity market when the index is unusually high, on the expectation the index will decline. It would go long the equity market when the index is unusually low, on the expectation that data surprises will turn up. For example, we isolated the points in the Citi Surprise Index when it moved above 50 points and then analyzed how stocks fared three and six months later. On average, equities are up 4.7 percent and 7.8 percent, respectively. So, a cursory analysis shows that acting based on past economic surprises is inherently risky.
Finally, in a similar vein, some have argued that growth acceleration remains the consensus narrative. With expectations set high, investors have room to be surprised on the downside. The idea is not entirely without merit. After all, in every year since 2011, the consensus has consistently been forced to slash estimates as the year has progressed. Indeed, the consensus almost always sees annualized growth improving from the first quarter of the year to the last.
There is only one problem: In 2018, the consensus sees no acceleration. According to the latest estimates from Bloomberg, the consensus sees growth running in place at about 2.5 percent in each of the next four quarters. Considering growth ran 2.5 percent in 2017, we’d hardly describe the current narrative as one of acceleration. Instead, the consensus can more accurately be described as seeing the economy hitting its cruising altitude.
Although focusing on the high-frequency data can be useful, one can often lose sight of the bigger picture. Historically, growth surprises tend to pile up in one direction. For example, in the 1990s, the consensus underestimated growth for years. Since the recession, we’ve seen the opposite. In the former case, productivity consistently came in stronger than anticipated. In the latter, productivity was a chronic disappointment. If economic-growth pessimists want to plead their case, they are better off talking about the outlook for productivity growth instead of recycling the tired arguments we’ve mentioned here.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Neil Dutta is the head of economics at Renaissance Macro Research, responsible for analyzing global trends and cross-market investment themes.
To contact the editor responsible for this story: Max Berley at mberley@bloomberg.net.
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