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Changes in equity analysts’ estimates are a good guide to corporate earnings momentum. September figures are reasonably encouraging – upgrades and downgrades across developed markets broadly balanced out.

The details show expected large downgrades among financial stocks, reflecting the “credit crunch”. However, there has been offsetting strength in other areas, including IT, telecommunications, materials and industrials.

As the chart shows, G7 industrial activity correlates with the world revisions ratio – upgrades minus downgrades divided by the total number of estimates. The ratio fell back in September but remains at a level consistent with economic expansion.

“Every dog has his day” – even the dismal Japanese stock market. The TOPIX index is again languishing at the bottom of league tables, having fallen 8% so far this year against an average rise of 7% in other major markets (as measured by the MSCI World ex Japan index). Four factors hint at better performance. First, the latest Ministry of Finance business survey was solid, suggesting the economy is bouncing back from early summer weakness – see chart. Second, corporate earnings continue to outpace expectations: analyst upgrades have outpaced downgrades in each of the last three months. Third, the liquidity backdrop has improved, with inflation-adjusted broad money recently growing faster than industrial output, having lagged in 2006. Finally, investor sentiment is depressed – arguably a precondition of a turnaround. According to Merrill Lynch’s global fund manager survey, pessimists on Japan now outnumber optimists for the first time since 2003.

The euro’s surge against the US dollar and sterling partly reflects a view that the Eurozone economy will “decouple” from expected US and UK weakness. Interesting then that the latest business surveys convey exactly the opposite message. While the US Philadelphia Fed and UK CBI manufacturing surveys remained upbeat in September, Eurozone purchasing managers have become markedly more bearish. Complacent ECB officials may soon suffer a rude awakening.

Mostly for fun, in 2002 we calculated a “three bears forecast” for the FTSE 100 index based on the average performance of UK stocks during and after the three largest bear markets of the last century: 1929-32, 1936-40 and 1972-74. Much to our surprise, the “forecast” has proved a remarkably accurate guide to the broad trend in the market – see chart.

Significant deviations from the forecast path have represented buying or selling opportunities. For example, the FTSE overshot the three bears by 10% in April 2006 but subsequently corrected sharply to close the gap.

At the recent August low the FTSE was 13% below the forecast – the largest downside deviation since the current bull run started in 2003. This appears to have been another buying opportunity, with the three bears suggesting the index will return to 6700-6800 later this year.

Simplistic historical comparisons are bound to break down at some point but the economic, liquidity and sentiment backdrop still seems consistent with higher prices.

The Federal Open Market Committee’s decision to lower the Fed funds and discount rates by 50 b.p. represents a bold attempt to forestall the negative economic impact of recent financial market dislocation. Visibility is low and there is a risk that the Fed has jumped the gun – current economic indicators remain consistent with expansion and market stresses were starting to abate before the surprise move. The consensus is convinced that further cuts will follow but a scenario of “one and done” should not be ruled out. Remember August 2005 in the UK?

Annual consumer price inflation fell further to 1.8% in August but the old retail price measure rebounded to 4.1%. The gap between the two is the largest since September 2000. The recent widening mainly reflects accelerating mortgage interest costs, which are included in the RPI but not CPI. Mortgage bills rose by 30% in the year to August.

On our calculations the average interest rate on outstanding mortgages stood at 6.0% in August, up from 5.3% a year before. Based on currently quoted rates and the large number of borrowers needing to refinance expiring fixed rate deals, the average rate is likely to reach over 6.5% by early 2008 – see chart.

The surge in mortgage bills will be a significant drag on consumer spending but may result in RPI inflation remaining above 4% going into 2008. With the labour market tightening recently, the MPC will be wary of a compensating pick-up in wage settlements when the pay round kicks off early next year.

Some economists are starting to talk about rate cuts before year-end but I think the MPC is on hold for the foreseeable future.

11 forecasters in a Wall Street Journal survey rate the chances of a US recession in the next 12 months at 50% or higher. Since economists almost never predict recessions we can confidently assert that either a contraction has already started or – more likely – will be avoided.

US GDP grew at a 4.0% annualised rate in the second quarter and is likely to register further expansion in the third. Despite housing gloom consumers continue to spend: real outlays rose in July and available evidence suggests a further gain in August. Payrolls growth has slowed sharply in recent months but this partly reflects a surprise cut in government jobs, which is likely to prove temporary. Daily information on withheld tax receipts does not suggest the labour market has fallen off a cliff.

Money market dislocation will hit growth in the fourth quarter but the impact is uncertain and will depend on how long current conditions persist. A useful summary measure of system dysfunction is the spread between the discount rates on non-financial commercial paper and Treasury bills. On three month paper the gap is currently 110 basis points – far above the normal 25-50 b.p. and a level historically consistent with recessions. I will be concerned if this gap fails to narrow significantly by mid October.

The chart shows two versions of our US recession probability indicator, designed to look out six months. The original version suggests recession risk remains low but arguably fails to capture current market dislocation. A new version was therefore estimated including the commercial paper / Treasury bill spread. Assume conservatively that the spread averages 100 b.p. over the remainder of the year. Even on this basis the model suggests the odds are (just) against recession.

Our MPC-ometer forecasts an 8-1 vote for unchanged rates in September with one lonesome dove seeking a quarter-point cut. No great surprise there. The bigger issue is whether the next move in rates will be up or down. Assuming GDP growth and inflation follow the MPC’s forecasts and other inputs remain at current levels, the MPC-ometer assigns a 20% probability to another rate rise before year-end, with a 10% chance of a cut. I think rates are on hold for the foreseeable future but money growth needs to moderate to convince me that the next move will be down. Historically rate peaks have usually been signalled by a slowdown in narrow money growth as measured by “non-interest-bearing M1” – currency in circulation and conventional current accounts. M1 has picked up recently, its annual increase jumping from 2% in May to 10% in July. Broad aggregates are even stronger: the widest M3 measure grew by an annual 16% in July – the highest since 1996. Tighter credit market conditions should contribute to a slowdown but rates of monetary expansion need to fall significantly to be compatible with the inflation target over the medium term.

Gloom-mongers think a credit crunch will slow global growth, hit corporate earnings and weaken stock markets. They could be right but I am not betting that way. A key reason is the strength of global money trends. G7 real broad money growth is running at 7% year-on-year, the highest for five years and far above industrial output expansion of 2%. This implies there is “excess” money available to support economies and markets.