The gap between hard and soft data is one of the biggest stories in the market right now. What’s giving us the more accurate picture: surveys tracking activity or those polling sentiment? We’re going to explore the debate this week through a series of questions, asking what we mean by hard and soft data, the source of the gap and what it means for companies and markets.
What do we mean by ‘hard’ and ‘soft’ data?
In this context….
- “Hard data” refers to tangible activity such as GDP
- “Soft data” refers to surveys measuring sentiment – usually company or consumers
Hard data can be adjusted or amended. Some data falls in-between. But for our purposes the important point here is the gap between surveys measuring activity versus those measuring confidence.
Where’s the gap?
The gap is most obvious in the US, where a stunning rise in consumer and business confidence has taken the gap between hard and soft data to “record levels”, according to Morgan Stanley.
“Upside surprises appear to be completely driven by the soft data while hard data are simply coming in about as expected,” Morgan Stanley, economist Ellen Zentner.
In the UK last year, unexpectedly high consumer confidence drove activity in a burst of animal spirits that left forecasters floundering. In 2017, overall activity remains resilient, but the reality of sterling’s fall has bitten consumers. And, we’re none the wiser on what BREXIT means longer term, creating the possibility of further gaps opening up between current data and sentiment.
In the Eurozone, the first estimate of Q1 GDP of 0.5% was in line with boosted expectations. If optimism is justified anywhere right now, it’s probably here – applying our now customary caveats.
Why is the US gap so big?
There’s a potentially huge gap in the US between current and future government policy – especially with regard to taxation. This is creating a disparity between hopes and actions in some areas, as the Fed noted in the minutes from its mid-March meeting:
Business optimism remained elevated in a number of Districts. A few participants reported increased capital expenditures by businesses in their Districts, but business contacts in several other Districts said they were waiting for more clarity about government policy initiatives before implementing capital expansion plans.
Why does it matter?
The Atlanta Fed (focused on hard data) had a mid-April forecast of 0.5% for Q1 US GDP growth against the New York Fed (focused on soft data) forecast of 2.6%. Two narratives pulling in opposite directions and widely different forecasts increases the risk that investors, companies, governments and central banks call it wrong. And when the economy and central bank at the epicentre are the US and the Fed this has global implications.
Just to underline how head-scratching this all is, the Atlanta Fed is now forecasting annualised GDP growth of 4.2% for Q2, whilst the New York Fed is predicting 2.3% in a complete reversal of their previous positions. At least both are suggesting an improvement.
So, who’s calling it right?
An impossible question for two reasons.
- There isn’t an absolute truth. Annualised Q1 US GDP growth was 0.7%. So hard data ‘won’…right? Not exactly, the official figure is heavily seasonally adjusted and is just a first estimate at this stage.
- Animal spirits. The relationship between hard and soft data is symbiotic. If companies and consumers are confident in the future this can create a strong growth narrative – as we saw in the UK last year. Plus hard data is historic – so ignore soft signals at your peril !
The Fed’s statement after last May’s decision to hold rates doesn’t dismiss the GDP data, but it does put in the context of a potential pick-up in Q2. So appears to be picking a point in between hard and soft. That makes both wrong – it’s a matter of how wrong.
What about earnings?
Company earnings are hard data in that they measure activity (caveat for accounting variations) but also contribute to confidence. So it’s good news all-round that numbers are looking up.
So far, S&P 500 Q1 earnings are up 11.7% YoY, according to BofA Merrill Lynch, 5.9% excluding financials and energy. In Europe, the Q1 earnings season is still young, but earnings growth is forecast to hit 13.9%, according to Thomson Reuters I/B/E/S and, for the first time in seven years, analysts are upgrading their forecasts at this point.
The UK is a separate case right now and a more mixed story. There are higher earnings expectations for the internationally-oriented FTSE 350, but falling forecasts for the more domestically- focused FTSE Small Cap, which has fewer companies benefiting from sterling’s fall and greater domestic exposure.
What does this mean for markets?
Putting all this together, we don’t think it’s totally a cop-out to say that we need more data – or, more specifically, more policy detail – to work out where we are. Policy, Policy, Policy is the theme of 2017, as we discussed last week.
Whilst we’re in wait and see mode, it seems that capital markets remain pretty much wedded to the soft data narrative linked into the idea of US policy support, global growth and reflation. We’ve had wobbles, but VIX – the volatility or fear index – is still at record lows. This could be because investors have low levels of fear or, more likely, because ample liquidity is still absorbing the shocks.
If much of the upside seems baked in, there’s a risk that anything less will disappoint in the longer term. Perhaps there is also a Goldilocks scenario for investors where hard data keeps coming in just too weak to move central banks. But how long can investors sustain the idea that slightly bad news is good news? What price another year of mediocre growth?
EYs 16th Capital Confidence Barometer suggests that while global companies have better hopes for the economy and capital markets, only 58% believe that growth will come from organic sources in the next 12 months – the remainder are looking to M&A, JVs and alliances to fill the gap. Economic growth is one thing, but companies also need to future proof their business, protect supply chains, acquire talent, react to consumer behaviour, and react to activists – all themes that came out in our survey.
Perhaps companies are more optimistic because enduringly positive deal conditions provide a means to effectively ‘defy’ the cycle? In which case, do we need to think differently about ‘confidence’ and whether uncertainty and record deal levels can co-exist?
More on the 16th UK Capital Confidence Barometer next week.