Sunday, February 17, 2013

Pay Attention to Citi Economic Surprise Index

On January 25th, the Citi Economic Surprise Index (CESI) crossed through the zero line and became negative. To be sure, no single factor predicts all changes in equity prices. But, you want to pay attention to CESI, especially if other factors start to point in the same direction. According to JPM, the last 7 times that CESI went negative, over the next 3 months, the $SPX had average upside of just 1% versus an average downside of 8%. That's poor risk/return.

A few key points:
  1. In the past, a negative CESI has led a decline in $SPX. In the first chart below, the yellow areas are where CESI turned negative since 2007. $SPX (blue line) followed each time, losing 8-10% or more each time. There was a two month lag in mid-2011 where $SPX stalled before a large correction. 
  2. Part of this correlation relates to EPS revisions (second chart). JPM points out that when CESI heads lower, EPS estimates are typically revised lower. And vice versa. 
  3. Another part of this correlation relates to valuation. When CESI heads lower, PE ratios typically also contract, and vice versa. 
  4. A final component to this correlation is that bond yields move with macro expectations. When macro disappoints, yields head lower and bonds outperform equities (third and fourth charts). 
  5. When CESI is -90 or lower, macro expectations have often bottomed (fifth chart). 
Charts below the break
CESI vs $SPX: the yellow areas are where CESI turned negative since 2007. $SPX (blue line) followed each time, losing 8-10% or more each time. Note also that global macro surprises are highly correlated with US macro surprises.

CESI vs EPS revisions: JPM points out that CESI (blue line) correlates well with EPS revisions. This chart is from August 2012. To wit, note that FY13 EPS consensus of $112 implies heady growth of more than 10% from FY12.

CESI vs forward PE ratios: In a prior post, we have have noted that there is a high correlation between CESI and valuation; when economic measures exceed expectations, multiples expand, and vice versa. See chart here.

CESI vs Treasury yields: Disappointing economic data (black line) leads to a decline in the treasury rates, and vice versa. The bond market knows.

CESI vs Equity/Bond relative performance: In summary, therefore, you would expect bonds to outperform equities (yellow line) when CESI (blue line) declines, and vice versa. And, in fact, that appears to be the case historically.

When CESI goes to -90 or more, $SPX often bottomed. A Fat Pitch. Chart below from the excellent SentimenTrader site.