This article discusses an unusual but interesting indicator I designed to gauge the background economic noise emanating from an economy and show how it impacts on sentiment and reflects key underlying trends.
The chart comes from the latest edition of the Weekly Macro Themes where we also looked at the indicator for Europe and emerging markets.
As with the usual format, here's the chart and the methodology can be found below. Notice on the chart how the indicator has taken a turn downwards recently.
The Economic Noise Index is designed to gauge background economic noise and expresses as either more positive noise or more negative noise. It incorporates 2 components: the Citi Economic Surprise Indexes, and the Economic Policy Uncertainty Indexes.
Basically a higher reading for this index indicates more positive noise: i.e. economic data is generally beating expectations and surprising to the upside, and economic policy uncertainty is generally lower than usual.
Lately economic data has been missing against arguably over-optimistic expectations and policy uncertainty has been elevated in the Trump era and as the Fed moves towards monetary policy normalization. Clearly the worse these factors become and the more persistent they stay bad the greater the likelihood is of a market accident, for example the almost mythical 5% correction.
Looking at the chart, the economic noise index appears to work as a contrarian indicator, with bearish signals being generated from the index moving to extreme positive noise and then rolling over, and bullish signals generated when it reaches extreme levels of negative noise.
Thus it's a fair interpretation that with the turn down in the indicator in recent months that the US economic noise indicator is sounding a cautionary tone on the market outlook. Another one to add to the growing list of bearish evidence.