Blog - Investing Notes
Blog Synthesis: The Economy and the Stock Market
The U.S. economy is a very complex system, with indicators therefore ambiguous and difficult to interpret. To what degree do macroeconomics and the stock market go hand-in-hand, if at all? Do investors/traders: (1) react to economic readings; (2) anticipate them; or, (3) just muddle along, mostly fooled by randomness? Here is a listing of past blog entries on relationships between economic indicators and the stock market.
To discuss this research, go to the Economic Indicators Forum.
PPI and the Stock Market ...PPI is not a reliable signal for either short-term or intermediate-term trading of the broad U.S. stock market.
Public Debt, Inflation and the Stock Market ...simple tests suggest that U.S. government deficit spending has a slight tendency to stimulate the U.S. stock market but has no reliable impact on the inflation rate over the next year or two. Annual variability of data makes trading on these conclusions risky.
U.S. Stock Returns Around Dates of FFR Changes ...evidence indicates that the days around announcements of a change in the Federal Funds Rate offer little in the way of reliable event trades.
Update: The Federal Funds Rate and the Stock Market ...simple tests of data since 1990 do not support beliefs that the level of the Federal Funds Rate and changes in the rate are reliable indicators of future U.S. stock market behavior.
The Dollar-Euro Exchange Rate and U.S. Stocks ...recent trends in the dollar-euro exchange rate appear not to be useful short-term or intermediate-term trading signals for U.S. stocks.
The Countercyclical Value Premium? ...investors may be able to exploit time variation of the value premium based on the state of the economy, moving out of (into) value as recessions approach (end).
Which Economic Data Announcements Matter? ...the nonfarm payroll, GDP advance and ISM manufacturing data releases move markets the most, affecting interest rates and currency exchange rates more than stocks. Impacts are most pronounced immediately after release.
Bank Failures and Stock Returns ...evidence from simple tests does not support a belief that there is a systematic relationship between the annual rate of FDIC bank closings and assistance transactions and annual U.S. stock market returns.
ECRI's Weekly Leading Index and the Stock Market ...ECRI WLI movements probably coincide with or slightly trail stock market behavior, offering no trading intelligence over the short or intermediate terms. This coincident/trailing connection may tend to break down during stock market declines.
An International Test of Common Stock Return Indicators ...there is solid evidence that stock returns have a predictable component, captured at least partially by interest rate variables, across international markets.
The ADP Employment Report and Stock Returns ...the ADP National Employment Report has little (some) power to predict near-term stock returns (return volatility). Evidence suggests that stock returns predict changes in employment better than vice versa.
Do Any Sector ETFs Reliably Lead or Lag the Market? ...there is little evidence that sector ETFs systematically lead or lag the overall market over the past decade.
Oil Price Shocks and the Stock Market: The Good, the Bad and the Indifferent ...an oil price shock can be good, bad or indifferent for the overall U.S. stock market according to the cause of the shock. A shock driven by global economic expansion is a good sign for stocks.
CPI and the Stock Market Over the Intermediate Term ...CPI data alone is not useful for intermediate-term trading of the broad stock market. A good three-month inflation forecast is apparently needed to exploit any intermediate-term relationship between CPI and stock prices.
Are Monthly CPI Announcements Tradable Events? ...total and core CPI announcements by themselves have little or no explanatory power for short-term stock returns over the period 1/94-4/08, with a negative average immediate effect in the 2000s canceling a positive average immediate effect in the 1990s.
Macroeconomic Shocks and the Stock Market ...inflation shocks significantly affected the U.S. stock market over the past half century, with disinflation (inflation) shocks increasing (decreasing) stock prices and promoting boom (bust) conditions.
Industrial Production as a Predictor of Stock Returns ...while of little value to traders, the industrial production (output) gap may have some meaningful predictive power for broad U.S. stock returns over relatively long periods.
Predicting Bear Markets ...investors may be able to exploit the predictive power of the inflation rate and the yield curve to "switch out" of bear markets and thereby beat a buy-and-hold approach.
Do Copper Prices Lead the Broad Equity Market? ...evidence from simple tests indicates no tradable lead-lag relationship between the price of copper and a broad stock market index.
Do the Chemicals and Metals/Mining Industries Lead the Broad Equity Market? ...evidence from simple tests indicates that the chemicals industry and the precious metals and mining industry do not reliably lead or lag the broad U.S. equity market. Chemicals (precious metals and mining) tend to move with (independently of) the broad stock market on a quarterly basis.
Currency Exchange Rates and Stocks (a Carry Trade?) ...the relationship between major currency exchange rate variations and stock returns is inconsistent and, when it appears, largely coincident rather than leading.
Does the Fiscal Deficit Really Affect Asset Valuations? ...the trajectory of the federal fiscal deficit significantly affects the way investors interpret economic growth and Federal Funds Rate hikes.
Reliable Intraday Trades on Federal Funds Rate Decisions? ...stocks react to the surprise element in scheduled Federal Funds Rate announcements. There may be reliable trades in short-term continuation (reversal) of stocks after an initial spike down (up), especially for financial and information technology stocks.
Sector Rotation Based on Monetary Policy ...investors can significantly outperform the broad U.S. stock market by rotating into cyclical (noncyclical) sectors when the Federal Reserve discount rate begins falling (rising).
Are Monthly Non-farm Employment Announcements Tradable Events? ...change in non-farm employment by itself does not offer enough short-term explanatory power with respect to the stock market to justify trading on the announcement.
The Disconnected Federal Funds Rate? ...by trying to make the Federal Funds Rate lead rather than respond to economic fundamentals, the Federal Reserve causes a disconnect between short-tem and long-term interest rates.
Crude Oil Price and Energy Sector ETF Returns ...although energy sector ETFs track the price of crude oil fairly well over long periods during 1999-2007, short-term variations in the two series are only slightly related.
Crude Oil Price and Stock Returns ...while a dramatic move up (down) in the price of crude oil represents a modest near-term headwind (tailwind) for the overall stock market, oil price is generally not a good predictor of stock market behavior.
Stock Returns After T-bill Yield Shocks ...evidence does not support a model of funds flowing predictably back and forth between stocks and T-bills as investors overreact and correct to perceived crises.
Responding to Energy Price Inflation at the Federal Reserve ...this model indicates that the Federal Reserve should (and will?) accommodate, not fight, energy price inflation.
Perfect Sector Rotation ...realistic assumptions about business cycle predictability make it unlikely that an investor/trader can outperform the broad stock market using a sector rotation strategy. Moreover, an arguably easier-to-time flight to cash during the first half of recessions offers greater potential.
The Effects of Inflation Rate Trend and Volatility on Stock Returns ...investors/traders appear not to consider recent inflation rate trend or volatility in deciding whether to buy or sell stocks.
Home Prices and the Stock Market ...data from the past 39 years indicates at most a weak contemporaneous relationship between the overall stock market and the residential real estate market. If anything, there is a some tendency for stocks to be relatively strong (weak) when home prices are relatively weak (strong).
T-note Yield Shocks and Stock Returns ...there is practically no overall relationship between last-month change in T-note yields and next-month stock returns since the beginning of 1990. Extreme T-note yield shocks, negative and positive, may be bullish for stocks, but small subsample sizes greatly limit the reliability of this conclusion.
Inflation, Monetary Policy and the Stock Market ...inflation levels and expectations are key to equity market performance, and monetary policies that successfully manage inflation risks would promote stock market stability.
Leading Economic Indicators and the Stock Market ...the revised index of Leading Economic Indicators is probably not a useful indicator for short-term or intermediate-term trading of the broad stock market.
Personal Consumption Expenditures and the Stock Market ...Personal Consumption Expenditures is not a leading indicator for the stock market. There is very weak evidence that PCE lags stocks by a couple of months.
Update: Does Non-farm Employment News Move Stocks? ...while non-farm employment and the stock market may have very weak tendencies to move together and reinforce each other over the short and intermediate terms, other sources of stock market variability swamp their relationship.
GDP Growth and Stock Market Returns ...there is no relationship between quarterly change in GDP and concurrent quarterly stock returns. Quarterly stock returns are weak indicators for GDP changes three to nine months in the future. Quarterly changes in GDP do not predict future stock returns.
Money Supply (M2) and the Stock Market ...M2 money supply is not a useful indicator for concurrent or intermediate-term future stock market returns.
T-bill/T-note Yield Flattenings and Bear Markets ...there may be some relationship between yield curve inversions/flattenings and future stock market behavior, but weak theory and small sample sizes drastically undermine confidence in predictability.
Reader Suggestion: Signals from the T-note/T-bill Yield Spread? ...the T-note/T-bill yield spread does not appear to be a useful indicator of future stock returns.
Stock Valuation Indicator Flyoff ...over the last 80 years, a few price-normalized variables (price-dividend, price-earnings, price-output and price-consumption ratios) and the approximate consumption-aggregate wealth ratio have been the best stock market indicators.
Essential Ingredients for a Stock Market Boom ...stock market booms arise from the confluence of strong economic growth and low inflation. Excessive (?) monetary policy reaction to rising inflation kills the booms.
Inflation Forecast Reliability ...our technical inflation rate forecasting methodology generates forecasts continually in catch-up mode, with accuracy generally degrading from early months to late months for each forecast.
Which Shocks Mean More, Total CPI or Core CPI? ...changes in total inflation rate wins a close one over changes in core inflation rate as a proxy for stock market discount rate shocks.
Earnings, Inflation and Stock Returns ...neither change in aggregate earnings nor the inflation rate alone is a good concurrent indicator for the overall stock market returns on a quarterly basis. However, because earnings growth and inflation are interrelated, they may together help forecast stock market behavior.
Market-Leading Industries ...some industries (such as financial and retail positively, and petroleum and metals negatively) lead the overall stock market. However, the indications are not economically significant for traders.
Combining Momentum and Value Styles ...investors can enhance returns by combining value and momentum styles, leaning toward momentum when the yield curve is normal and value when the yield curve is inverted.
Reader Question: Why Are U.S. Markets Not Discounting the Threat of Middle East Oil Supply Disruption? Which are the probabilities for these three possible conclusions? We suggest 10% / 40% / 50%.
Should Equity Investors Hope for Good or Bad Economic Forecasts? ...equity investors should be contrarian when considering economic forecasts. Bad is good.
Does Productivity Drive Stock Prices? ...quarterly productivity changes are not useful as trading signals, but the long-term productivity trend affects the stock market because it suppresses inflation, and probably boosts corporate earnings.
Bad News is Good News, Except When... ...good (bad) macroeconomic news is bad (good) for broad stock indices during expansions and good (bad) during recessions.
In summary, recent research indicates that economic indicators offer few clues to traders and slightly contrarian cues for investors.
