Disappointing U.S. economic figures aren't cause to flee U.S. equities, according to Pavilion Global Markets.
American data have come in on the soft side in 2015, with the exception of robust payroll growth. Last week, for instance, industrial production rose just 0.2 per cent month-over-month in January, while housing starts and building permits figures for the month also came in below the consensus estimates.
Citigroup's U.S. economic surprise index has tumbled over the past few months from around 40 in late December to -45.6 this as of Monday morning. This level indicates that U.S. economic data released over the past three months has missed the consensus estimate by about a half a standard deviation.
Pavilion strategists Pierre Lapoint and Alex Bellefleur believe this index is a somewhat contrarian indicator that is currently pointing towards an extension of the rally in U.S. equities over the next six months.
"When economic data ceases to disappoint, equity returns get a second wind," they write. "Since the Citigroup surprise index was created in 2003, whenever the economic surprise index was between -50 and -75, the S&P 500 advanced almost 8 per cent on average in the following six months."
This view is a riff off of the "bad news is good news" mantra that became popular in 2013. At that time, underwhelming economic data was considered to be a positive for U.S. equities, as it presumably pushed off the beginning of a reduction in the Federal Reserve's asset purchases further out into the future.
As the strategists note, surprise indexes tend to be mean-reverting: After a stretch in which economists' forecasts prove too be too optimistic, sentiment usually swings too far in the opposite direction. But, as the chart shows, bad news can, in fact, get too bad – the S&P 500 doesn't perform very well in the next six months if the economic surprise index falls below -75.
U.S. equities have managed to largely shake off poor data, with the S&P 500 and Dow Jones industrial average closing at all-time highs on Friday.
"The fact that equities held up nicely in the face of disappointing economic data bodes well for the future," says Pavilion.
However, a trough in Citigroup's U.S. economic surprise index may not be imminent, judging by the seasonal factors at play. Around this time last year, the Globe's Scott Barlow observed that this metric bottomed out between May and July from 2010 to 2013. In 2014, the low-water mark for this index came in April.
Canadian investors looking to increase their exposure to U.S. equities should be aware that an attractive buying opportunity may be on the horizon, if Pavilion's analysis holds true.