Blog RSS Feed:

Blog - Investing Notes

October 18, 2007 - Update: Should the "Anxious Index" Make Investors Anxious?

Since 1990, the Federal Reserve Bank of Philadelphia has conducted a quarterly Survey of Professional Forecasters. The American Statistical Association and the National Bureau of Economic Research conducted the survey from 1968-1989. Among other things, the survey solicits from experts on the economy the probabilities of recession in each of the next four quarters. The "Anxious Index" is the probability of recession in the next quarter. When professional forecasters are relatively pessimistic (optimistic) about the economy, does the stock market go down (up) over the coming months? Using raw survey results and quarterly S&P 500 index data from the third quarter of 1968 through the second quarter of 2007 (156 surveys), we find that:

The following scatter plot relates the forecasted probability of recession for the next quarter to the change in the S&P 500 index over that same quarter since survey inception. No relationship is visually obvious. In fact, the Pearson correlation and the R-squared statistic for these series are 0.00, confirming that there is no relationship between forecasted probability of recession and stock market return one quarter into the future.

Might extreme values of the forecasted probability of recession be meaningful for stocks?

The next chart recasts the data in the prior one by ordering the forecasted probability of recession for the next quarter from lowest (2%) to highest (74%). The horizontal axis is therefore not time sequential. There are no ranges of forecasted probability that appear to be predictive for next-quarter U.S. stock returns.

Are there any relationships between forecasted probabilities of recession and stock returns?

The final chart examines additional relationships between forecasted probabilities of recession and quarterly S&P 500 index returns over the entire sample period. Specifically, it plots the correlations for many different combinations of: (1) economic forecast intervals (3, 6, 9 and 12 months into the future); and, (2) intervals of S&P 500 index behavior (from 12 months back into the past to 12 months forward into the future). This chart shows the following:

• In general, there are some noticeable correlations between forecasted probabilities of recession and past S&P 500 index returns. There are no noticeable correlations between forecasted probabilities of recession and future S&P 500 index returns.
  
• Specifically, if the stock market has been rising (falling), shorter-term forecasts of the probability of recession tend to be lower (higher). In other words, forecasters seem to regard the past behavior of stocks as predictive for the economy over the next couple of quarters. The past behavior of stocks does not greatly influence their outlook 9-12 months out.

In summary, the "Anxious Index" from the Survey of Professional Forecasters is of no use in predicting future U.S. stock market behavior. Instead, the stock market is somewhat predictive of the behavior of economic forecasters.

For related research, see Blog Synthesis: The Wisdom of Analysts, Experts and Gurus. See especially our blog entry of 7/12/07 on the ability of professional economists to forecast the stock market directly.