To Gauge the Global Economy’s Health, Strip Out Commodities

According to some big institutions with loud megaphones like the Fed and IMF, the world economy is weak, and they are worried about it. The media and punditry also took their turn, seizing upon recent data as evidence, from persistently low inflation in the US, UK and eurozone to China's most recent trade numbers. However, a closer look reveals the real story underlying these headline figures seemingly isn't a fragile world economy-it's falling commodity prices.

At first blush, the numbers look lackluster, and if you stop there, we can see why some might conclude a slowdown is in the offing, pressuring stocks. For example, pundits attributed some of equity markets' Tuesday slide to weak Chinese September trade. While exports fell a less-than-expected -3.8% y/y^[i] (-1.1% y/y in RMB), imports dropped a whopping -20.5% y/y^[ii] (-17.7% y/y in RMB). Yowza! At the same time, headline CPI readings remain low-and some countries are in deflation.^[iii]UK September CPI fell -0.1% y/y, the second negative read this year. Eurozone August CPI slowed to 0.1% y/y from July's 0.2% y/y and, Thursday, the US Bureau of Labor Statistics reported September CPI fell -0.2% m/m-0.0% y/y-both downticks from August.

On the surface, these figures don't look great, but there is a benign cause worth taking into account: Falling commodity prices have skewed the year-over-year comparisons. Consider China's import numbers. While a -20.5% y/y import drop sounds huge,^[iv] it isn't a huge outlier from the recent trend.

China's year-over-year import figures have been negative since November 2014. From January - May this year, they were often in the high negative teens.^[v] Not coincidentally, last fall was when commodity prices really went off a cliff. And consider: Growth in import volumes was "comparable to the same time last year ," according to one Chinese analyst. China's iron ore imports are near record highs, and crude oil imports are rising. Demand hasn't fallen off a cliff-prices have.

Falling commodity prices haven't just impacted trade. We see it in other data, too, including inflation and retail sales. Consider Core CPI, which strips out volatile components like energy and fresh food. UK Core CPI rose 1.0% y/y in September. Eurozone Core CPI rose 0.9% y/y in August. And US Core CPI sped to 1.9% y/y in September.^[vi]

Exhibit 1: Headline and Core Inflation for the US, UK and Eurozone

Source: St. Louis Federal Reserve, Office for National Statistics and Eurostat, as of 10/14/2015. From 12/31/2013 - 9/30/2015. September 2015 readings for the eurozone not available yet.

While some interpreted September US retail sales (0.1% m/m) as a sign of tepid consumer spending, consider: Retail sales are a slice of total consumer spending-services comprise much more. And if you strip out gasoline station sales-which are down -17% in the last year-retail sales rose 0.4% m/m. That's better than near-flat. Other measures of spending show similar trends.

These data all reflect the decline in commodity prices over the past several years. Oil has grabbed the most headlines ever since its sharp decline began last summer, but commodities overall have been hit hard, largely due to a supply glut. Global supply has outpaced global demand, leading to falling prices. It takes a while to work through excess supply, and since Energy and commodities prices influence inflation gauges, China imports a lot of commodities and consumers spend at gas stations, this skews data worldwide.

While falling commodity prices hurt commodity producers, they are a positive for commodity consumers, mitigating input costs for firms and freeing up cash for consumers. For example, consider recent consumer spending stats for China's "Golden Week" national holiday. Restaurant and retailers' sales amounted to 1.082 trillion yuan^[vii]-equivalent to Kuwait's total economic output in 2014. Domestic entertainment spending boomed and four million tourists traveled abroad, with Japan, South Korea and Thailand the most popular destinations. Low inflation boosts real wages, benefiting consumption-dominated economies like the US, UK and the eurozone.^[viii] China has been shifting toward this direction, and the numbers from "Golden Week" serve as a nice counterpoint to fears of what a slowing Chinese economy means for the world.

In our view, this suggests many still aren't pricing in the oversized impact commodity prices are having on the data, leading to inaccurate conclusions about global macroeconomic conditions. Yes, commodity-oriented economies are hurting. But not all the world is commodity-oriented. You just have look closely at the data to see it.