Who’s Right?
On some days (a lot of days, including the first day of this week) Nvidia monopolizes financial media coverage. It beckons seductively to journalists, to say nothing of investors.
Jensen Huang's turned everyone into groupies. Like Rick James, he gestures hypnotically through a neon haze. ("I seen like, a green -- his aura or whatever. I seen it. It was green.")
But if you look past Nvidia, there's an entire stock market back there somewhere, and behind that, an entire economy. All of that pres
The economic surprise index is more informative than a lot of people think. Intuitively, the idea that economists are often wrong doesn’t tell you anything new. But the index is helpful because of a simple truism for almost every economic data point you can care to imagine: the number one predictor of next month’s data point is this month’s data point. The number two predictor is last month’s.
As a consequence, every forecasting shop out there–with their big fancy models built by Ph.D.s using dozens of inputs, gathering their own real-world real-time data, conducting their own surveys–can’t help but overweight the most recent data. As they should! It’s the single best predictor! (You could prop up an economic forecasting shop that just took the last few prints of every data point out there, slapped on a trend factor, and call that your forecast. You’d be close enough to right to be mistaken for an economist).
In consequence, when the underlying state of the real economy changes, all forecasters are wrong all at once and in the same direction. If it’s just noise, the effect doesn’t last, but when there’s been a real change, the error persists. With a persistent, significant surprise index, the economy is screaming, “Something has changed!”
I spent some time looking at a chart of one of the surprise indicies (Citigroup), 2004-present. Two things jumped out:
– The index oscillates in a pretty constant range (-80 to +80) with a period of about 1 year. It isn’t perfectly periodic or consistently seasonal, but in almost every year the index will hit the top of the range, decline to the bottom, and rise again.
– The index correlates directionally with change in Treasury yield. When the index is rising [falling], 10Y yield is usually rising [falling]. However, the relative magnitude of moves changes a lot – i.e. the sensitivity of yield change to index change is not constant.
That’s it.
An indicator that regularly makes highs and lows every year seems not very informative. Unless you’re a Treasury trader, maybe.
It seems to me that surprise indicies merely reflect forecasters’ over-extrapolation whip-sawing around short-term fluctuations around a trend, but are too noisy to reveal much about whether the trend is changing.
JL – nice work. It’s no surprise that I agree with your conclusion.
This basically tracks with what I was saying. Things change, then after a few months, models adjust to the “new normal,” potentially followed by an over-correction. Fundamentals shift at a pretty glacial pace, so an oscillation per year sounds about right.
That it tracks treasury yield confirms it. Since the 10y is a pretty good proxy for the bond market’s expectations for how the economy is developing. If the economic surprise index is negative, then the zeitgeist regarding the state of the economy is negative, so 10Y yield would be expected to fall.