Economic Indicators

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? These blog entries address relationships between economic indicators and the stock market.

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Inflation Forecast Update

The Inflation Forecast now incorporates actual total and core Consumer Price Index (CPI) data for November 2014. The actual total (core) inflation rate for November is lower than (lower than) forecasted.

The new actual and forecasted inflation rates will flow into Real Earnings Yield Model projections at the end of the month.

Use the U.S. LEI for Long-term Stock Market Timing?

Referring to “Leading Economic Index and the Stock Market”, a subscriber inquired about using the Conference Board’s Leading Economic Index (LEI) for the U.S. to generate long-term U.S. stock market timing signals, as follows:  

“How about using the LEI in the following fashion?

Buy when the LEI rises by 1.0 % from its lowest point in the prior six months.
Sell when the LEI falls by 1.5% from its highest point in the last six months.

I used 1% as a buy because bear markets can end abruptly, not because I was torturing the data to confess. You could use 1.5% and I think still have robust results…changes in trend, which are rare, seem to be helpful. I bought the LEI data from the Conference Board and did some testing by hand using the above going back to 1969. I think I found some interesting results. …It gave early sell in 2006… The signal date was the date of the release… Most of the benefit of the trading system comes within the last 14 years.”

Using the monthly change in LEI data from archived Conference Board press releases during June 2002 through October 2014 (146 months), we find that: Keep Reading

Components of U.S. Stock Market Returns by Decade

How do the major components of U.S. stock market performance behave over time? In his October 2014 paper entitled “Long-Term Sources of Investment Returns and a Simple Way to Enhance Equity Returns”, Baijnath Ramraika decomposes long-term returns from the U.S. stock market (as proxied by Robert Shiller’s S&P Composite Index) into four components:

  1. Dividend yield
  2. Inflation
  3. Real average change in 10-year earnings (E10)
  4. Change in the Cyclically Adjusted Price-Earnings ratio (CAPE, or P/E10)

He further segments this decomposition by decade. Using his decomposition by decade for 1881 through 2010 (13 decades), we find that: Keep Reading

Housing Starts and Future Stock Market Returns

Each month, the Census Bureau announces and the financial media report U.S. housing starts (seasonally adjusted and annualized) as a potential indicator of future U.S. stock market returns. Release date is about two weeks after the month being reported. Moreover, new releases may substantially revise recent past releases, so that the Census Bureau historical data set effectively has a longer lag. Does this economic indicator convey useful information about future stock market returns? To investigate, we relate future S&P 500 Index returns to housing starts at the monthly release frequency. Using monthly data for the S&P 500 Index and for seasonally adjusted annualized housing starts over the period January 1959 through September 2014 (621 months), we find that: Keep Reading

New Home Sales and Future Stock Market Returns

Each month, the Census Bureau announces and the financial media report U.S. new home sales (seasonally adjusted and annualized) as a potential indicator of future U.S. stock market returns. Release date is about three weeks after the month being reported. Moreover, new releases may substantially revise recent past releases, so that the Census Bureau historical data set effectively has a longer lag. Does this economic indicator convey useful information about future stock market returns? To investigate, we relate future S&P 500 Index returns to new home sales at the monthly release frequency. Using monthly data for the S&P 500 Index and for seasonally adjusted annualized new homes sales over the period January 1963 through September 2014 (621 months), we find that: Keep Reading

Earnings per Share Growth in the Long Run

Can the U.S. stock market continue to deliver its historical return? In the preliminary draft of his paper entitled “A Pragmatist’s Guide to Long-run Equity Returns, Market Valuation, and the CAPE”, John Golob poses two questions:

  1. What long-run real return should investors expect from U.S. equities?
  2. Do popular metrics reliably indicate when the U.S. equity market is overvalued?

He notes that the body of relevant research presents no consensus on the answers to these questions, which both relate to long-term growth in corporate earnings per share. Recent forecasts for real stock market returns range from as low as 2% to about 6% (close to the 6.5% average since 1871), reflecting disagreements about how slow GDP growth, low dividends, share buybacks and the profitability of retained earnings affect earnings per share growth. The author introduces Federal Reserve Flow of Funds (U.S. Financial Accounts) and S&P 500 aggregate book value to gauge effects of stock buybacks. He also assesses the logic of using Shiller’s cyclically adjusted price-earnings ratio (CAPE or P/E10) as a stock market valuation metric. Using S&P 500 Index price and dividend data, related earnings data and U.S. financial and economic data as available during 1871 through 2013, he concludes that: Keep Reading

Unemployment Rate and Stock Market Returns

The business media and expert commentators sometimes cite the U.S. unemployment rate as an indicator of economic and stock market health, generally interpreting a jump (drop) in the unemployment rate as bad (good) for stocks. Conversely, investors may interpret a falling unemployment rate as a trigger for increases in the Federal Reserve target interest rate (and adverse stock market reactions). Is this indicator in fact predictive of U.S. stock market behavior in subsequent months, quarters and years? Using the monthly unemployment rate from the U.S. Bureau of Labor Statistics (BLS) and contemporaneous S&P 500 Index data for the period January 1950 through September 2014 (777 months), we find that: Keep Reading

Employment and Stocks Over the Intermediate Term

U.S. job gains or losses are a prominent element of the monthly investment-related news cycle, with the business media and expert commentators generally interpreting changes in employment as an indicator of future economic and stock market health. One line of reasoning is that jobs generate personal income, which spurs personal consumption, which boosts corporate earnings and lifts the stock market. Are employment trends in fact predictive of U.S. stock market behavior in subsequent months, quarters and years? Using monthly seasonally adjusted nonfarm employment data from the U.S. Bureau of Labor Statistics (BLS) and contemporaneous S&P 500 Index data for the period January 1950 through September 2014 (777 months), we find that: Keep Reading

ECRI’s Weekly Leading Index and the Stock Market

Financial market commentators and media sometimes cite the Economic Cycle Research Institute’s (ECRI) U.S. Weekly Leading Index (WLI) as an important economic indicator, implying that it is predictive of future stock market performance. According to ECRI, WLI “has a moderate lead over cyclical turns in U.S. economic activity.” ECRI publicly releases a preliminary (revised) WLI value with a one-week (two-week) lag. Does this indicator usefully predict U.S. stock market returns? Using WLI values for January 1967 through mid-September 2014 and contemporaneous weekly levels of the S&P 500 Index, we find that: Keep Reading

Commercial and Industrial Credit as a Stock Market Driver

Does commercial and industrial (C&I) credit fuel business growth and thereby drive the stock market? To investigate, we relate changes in credit standards from the Federal Reserve Board’s quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices to future U.S. stock market returns. Presumably, loosening (tightening) of credit standards is good (bad) for stocks. The Federal Reserve publishes survey results about the end of the first month of each quarter (January, April, July and October). Using the “Net Percentage of Domestic Respondents Tightening Standards for C&I Loans” from the Senior Loan Officer Opinion Survey on Bank Lending Practices Chart Data for the second quarter of 1990 through the third quarter of 2014 (98 surveys), and contemporaneous S&P 500 Index quarterly returns, we find that: Keep Reading

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