Important disclosures appear at the back of this document

Global Economics Weekly

Issue No: 10/25June 30, 2010

Goldman Sachs Global Economics,Commodities and Strategy Researchat

https://360.gs.com

A More Global GLI: Easing from Very High Levels

Our Global Leading Indicator (GLI) has become an essential part of our toolkit andarguably the most critical indicator in our overall monitoring of the state of the cycle andof cyclical assets. It has continued to guide uswell through the deep and unusual events of the last two or three years.The global economy has changed significantlysince we first introduced the GLI in 2002, prompting us to revise it comprehensively in2006. And, while the 2008-2009 crisis andrecession proved an excellent ‘stress-test’ for the GLI, another four years on, we have onceagain improved both its components andunderlying methodology, to better reflect thenew global economic landscape. The improvedGLI is now more global, better correlated withthe industrial cycle and more stable.Our improved GLI comes at a particularlyimportant time for assessing the cycle. Wehave been highlighting for some time now thatthe original GLI was indicating some slowingin momentum. The improved version showsthis message more clearly, with a peak in theheadline already visible. This suggests that the pace of industrial growth is set to decelerate,although from extremely high levels, anoutcome that would be consistent with our GDP forecasts.Markets are increasingly focused on what thiskind of slowing in momentum will mean.Moderation in growth at this point in the cycleis generally consistent with

lower but positivereturns,

rather than with significant

negativereturns

. Although our US forecast is stillfirmly below consensus, our global forecastdoes not envisage a sharp slowdown. Thatsaid, we will continue to pay close attention tothe incoming data on this front, starting withthe new release of the GLI tomorrow.

Jim O’Neilljim.oneill@gs.com+44 (0)20 7774 2699Dominic Wilsondominic.wilson@gs.com+1 212 902 5924Kevin Dalykevin.daly@gs.com+44 (0)20 7774 5908Anna Stupnytskaanna.stupnytska@gs.com+44 (0)20 7774 5061Swarnali Ahmedswarnali.ahmed@gs.com+44 (0)20 7051 4009Alex Kelstonalex.kelston@gs.com+1 212 855 0684

y = 8.7454x + 0.3965R² = 0.2494-40-30-20-100102030-3.0-2.0-1.00.01.02.0GLI, %mom

Current GLI Momentum Consistent withLower But Positive SPX Returns

SPX Returns,3-month % change

Source: GS Global ECS Research

-15-10-505101598990001020304050607080910

% yoy

Improved GLI Headline Peaked in March

Headline GLI, % yoyIndustrial Production*, % yoy

* Includes OECD countries plus BRICs, Indonesia and South AfricaSource: GS Global ECS Research

June 30, 2010Issue No: 10/25

Global Economics WeeklyGoldman Sachs Global Economics, Commodities and Strategy Research

A More Global GLI: Easing from Very High Levels

We first introduced our Global Leading Indicator in 2002and last revised it comprehensively in 2006. Our goal atthe time was to find a way to provide earlier and morereliable signals on the global industrial cycle thanexisting leading indicators. In building the GLI, weendeavoured to ensure it is

early¸ global

in scope andlargely

independent of the market

, to make it as useful as possible to market participants.Since that time, the GLI has become an essential part of our toolkit and arguably the most critical indicator in our overall monitoring of the state of the cycle and of cyclicalassets. As we have shown many times before, the behaviour of many assets is very different depending onwhether the upcoming growth picture—as signalledthrough the GLI—is improving or deteriorating.Through the deep and unusual events of the last two or three years, it has continued to perform well, peaking in2006 and dropping sharply in the summer of 2008 beforethe Lehman collapse. It was also a crucial guide in thespring of 2009, signalling that the worst period of growthwas coming to an end around February and March of 2009—long before the scepticism about the emergingrecovery faded. Without it, we would not have had theconfidence to turn more pro-cyclical in our view of assetmarkets in April of last year.While the current GLI continues to guide us well, over the last eight years the global economy itself haschanged, as has the available set of variables withsufficient history, and we have continued to learn moreabout where we can improve performance further. Aswith our last revisions in 2006, four years after its initialrelease, we have once again improved both thecomponents and underlying methodology, another four years later. The result is a version of the GLI that is evenmore global, more correlated and more stable.The improved GLI is highly correlated with the previousversion and remains a very early and (now even more)highly correlated predictor of global IP trends. And theaverage performance of a wide range of assets variesgreatly depending on the direction of the improved GLI, just as with the original one.Our improved GLI comes at a particularly important timefor assessing the cycle. Although our original GLI hadnot shown a clear peak, we have pointed out for sometime that it has been distorted by trending issues in the past few months and that signs ‘under the hood’ have pointed to some slowing in momentum. The improvedGLI shows that message more clearly, with a peak nowvisible there. This suggests that the pace of industrialgrowth is set to decelerate, although from extremely highlevels, an outcome that would be consistent with our GDP forecasts.Markets are increasingly focused on what this kind of slowing in momentum will mean. As usual at this pointin the cycle, the key issue is the extent of deceleration.The acceleration phase in recovery inevitably ends andthat point was always likely to come in 2010H1. But, aswe show once again, while that shift means a moremoderate picture for risk assets, the deceleration isgenerally only a clear negative event if the slowdown issevere. Although our US forecast is still firmly belowconsensus, our global forecast does not envisage a sharpslowdown. That said, we will continue to pay closeattention to the incoming data on this front, starting withthe new release of the GLI tomorrow.

Preserving the Key Features of the GLI

The motivating factor for building our GLI was to providean early signal of the global industrial cycle, improving onthe available alternatives in three important ways:



An earlier signal.

The GLI appears on the dayfollowing the month for which it closes and our Advanced reading (which relies on a subset of data) isreleased around two weeks earlier. This is around amonth ahead of most official leading indicators, whose

-15-10-505101598990001020304050607080910

% yoy

Improved GLI Headline Peaked in March

Headline GLI, % yoyIndustrial Production*, % yoy

* Includes OECD countries plus BRICs, Indonesia and South AfricaSource: GS Global ECS Research

-3.0-2.5-2.0-1.5-1.0-0.50.00.51.01.598990001020304050607080910

% mom

Improved GLI Momentum Has Also Fallenfrom Very High Levels

Momentum GLI, % momIndustrial Production*, % 3mma

* Includes OECD countries plus BRICs, Indonesia and South AfricaSource: GS Global ECS Research

June 30, 2010Issue No: 10/25

Global Economics WeeklyGoldman Sachs Global Economics, Commodities and Strategy Research

lateness means that they are rarely closely followed asmarket releases, given that much of the informationthat goes into them has been ‘in the market’ for severalweeks.



A more explicit global focus

. The OECD’s aggregateleading indicators are composites of their nationalones. Our GLI has always included a number of indicators that are explicitly global in focus (Koreanexports, metals prices) and that we believe helpexplain the global cycle as a whole.



A limited reliance on market-based variables.

Equity markets and yield curves are importantcomponents in many other leading indicators. For market participants, who are trying to assess whether market moves are correct or not, this circularity is amajor drawback. While we still have a small number of market-influenced variables, the exclusion of bondand equity prices from our indices is deliberate.To achieve this, the GLI weighs a wide array of forward-looking information into ten major components. Thosecomponents are designed to provide independent butrelated information about the state of the global cycle.We currently report both the

Final GLI

and an

Advanced GLI,

which uses partial information to givean early reading nearly two weeks ahead of the Finalreading. For each, we report two measures: the

headlineGLI (

the year-over-year reading for the underlyingindicator), which is the most stable; and the GLI

momentum,

which focuses on nearer-term changes.It is now eight years since the GLI was introduced and sowe have followed it live through a full macro cycle. The2008-2009 crisis and recession were unusual both in their depth and severity and in the financial problems thatdrove them. This has been a good ‘stress-test’ for theGLI. As the charts show, the GLI performed well in theseexigent circumstances, deteriorating steadily throughearly 2008 and into the summer, plummeting in the post-Lehman period and signalling a trough between Februaryand March 2009, as we acknowledged in early April.Given this track record, why change? The answer is thatwe now have more history and more data series availablewith sufficient history than we had a few years ago, aswell as the lessons of our own continuing experience of using it. Alongside ongoing underlying changes in thestructure of the world economy, this means it is possibleto improve on the GLI’s performance.

A More Global, Stable, Correlated GLI

As with the last set of revisions (in 2006, four years after its release), we have made changes

both

to some of thecomponents of the GLI

and

to the methodology by whichthe GLI is aggregated and constructed. Together, thesechanges are designed to make the improved GLI more

global

(in keeping with the changes to the worldeconomy)

correlated

with the cycle and more

stable

(see

Global Economics Paper

No. 199, ‘An EvenMore Global GLI’, June 29, 2010, for more details).Of the ten original major components, five arecompletely unchanged, four are modifications of existingcomponents and only one is a direct substitution.The main changes are:



Tracking a more ‘global’ IP series.

Until now theGLI has been designed to predict the long-standing G7industrial production series produced by the OECD.Our improved GLI is designed to track a much broader OECD series (OECD + Major 6), which includes not just the entire OECD (including Korea, Mexico andTurkey from the N-11) but also the BRICs, Indonesiaand South Africa.



A more globally oriented and updated set of components.

The table on the next page summarisesthe main shifts. Five of the components from our previous GLI remain unchanged in the improvedversion (Korean exports; GS industrial metals index;US initial jobless claims; G4 consumer confidence;Japanese inventory-to-sales ratios). Four more have been expanded. Lastly, we have dropped the USdurable goods inventory/shipments ratio—which has