Sunday, October 07, 2007

Global Yield Curves, Earnings Growth, and Sector Returns / Hussman

This piece from William Hester from Hussman Funds takes a closer look at the yield curve. The trac record isn´t bad o far. It remains to be seen if China & Co will change the outcome this time.

William Hester wirft hier wie ich finde einen gelungenen Blick auf deb Zusammenhang von Zinskurven und Unternehmensgewinnen. Es sieht so aaus als wenn dieser Indikator in der Vergangenheit recht zuverlässig gearbeitet hat. Bleibt abzuwarten ob China & Co etwas wesentliches verändern werden.

Global Yield Curves, Earnings Growth, and Sector Returns
A reliable measure suggests slower global earnings growth ahead .....

Aside from the risk of slowing economic growth in the U.S. and the G7 countries, there is a strong risk that global earnings may slow enough to spook equity investors, especially those who are overweighting highly cyclical industries. Historically, global yield curves have provided guidance about this risk.

To see this, we can look at a composite of global yield curves and its relation to MSCI's World EPS data series. To measure the world's yield curve, we'll use the countries of the G7, excluding Japan, which has been out of step with other large economies for more than a decade. The graph below shows the global yield curve and the subsequent growth in World EPS. Both lines are smoothed to isolate the underlying trends. The global yield curve is a 12-month moving average of the yield curves of the 6 countries, each weighted by their GDP. The World EPS Growth rate is the subsequent two-year change in the two-year average of World EPS. So the last data point on that line represents the average earnings figure over the last two years versus the same calculation two years ago. That line ends in September 2005. The global yield curve is represented by the blue line, and is plotted on the left axis. The change in World EPS is in red, and is plotted on the right axis.

Changes in World EPS have tracked the shape of the global yield curve closely, usually with about a two-year lag. The global yield curve was inverted from 1979 until 1982. The smoothed World EPS eventually declined by 10 percent. The global yield curve inverted again in 1990, and World EPS declined by a similar amount. In 2001 when the smoothed yield curve flattened, but didn't invert, World EPS again declined by more than 10 percent. The 12-month moving average of the yield curve spread hit zero in July. It has since ticked up a fraction, as short rates have fallen in response to the world-wide credit crisis.

Much like the pattern in U.S. data, year-over-year changes in World EPS have very little correlation with the short-term returns of the MSCI World price index. But the current flatness of the global yield curve may turn out to be important. That's because more extended declines in World earnings have correlated with important declines in MSCI's World price index.

As the chart above shows there have been three meaningful declines in smoothed World earnings, bottoming in 1982, 1991, and 2001. Using monthly data, the smoothed Global Yield Curve bottomed in November 1981, May 1990, and April 2001. The corresponding declines in the MSCI World price index from those points were -17.3 percent, -19.4 percent, -35.0 percent, respectively (the peak-to-trough market losses were even worse).

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