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.
October 10, 2014 - Economic Indicators
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
October 9, 2014 - Economic Indicators
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
September 26, 2014 - Economic Indicators
Are changes in the money supply usefully predictive of stock market behavior? In his September 2014 paper entitled “Does Money Supply Growth Contain Predictive Power for Stock Returns?”, David McMillan investigates whether changes in U.S. money supply reliably affect future U.S. stock market returns. He examines also whether any predictive power of money supply growth is independent of dividend yield, interest rates and other economic variables. He focuses on M2 money stock but also considers M1 money stock and the non-M1 components of M2 (saving deposits, small time deposits, retail money market mutual funds), M4 and the monetary base and its components (currency in circulation and reserves). He considers predictability horizons of one month, one year, five years, 10 years and 15 years. Using monthly data for stock index levels, dividends and earnings from Robert Shiller and seasonally adjusted money supply and other economic data from FRED during January 1959 through December 2012 (54 years), he finds that: Keep Reading
September 22, 2014 - Economic Indicators
The Conference Board “publishes leading, coincident, and lagging indexes designed to signal peaks and troughs in the business cycle for major economies around the world,” including the widely cited Leading Economic Index (LEI) for the U.S. Does the LEI predict stock market behavior? Using the as-released monthly change in LEI from archived Conference Board press releases and contemporaneous dividend-adjusted daily levels of SPDR S&P 500 (SPY) for June 2002 through August 2014 (146 monthly LEI observations), we find that: Keep Reading
September 17, 2014 - Economic Indicators
The Inflation Forecast now incorporates actual total and core Consumer Price Index (CPI) data for August 2014. The actual total (core) inflation rate for August 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.
August 25, 2014 - Economic Indicators, Equity Premium, Fundamental Valuation
Is the U.S. stock market in a Federal Reserve-driven bubble that is about to burst? In his August 2014 paper entitled “Fed by the Fed: A New Bubble Grows on Wall St.”, Oliver Dettmann examines how shifts away from quantitative easing by central banks, and the introduction of rising interest rates, may affect current valuation levels of the U.S. stock market. He focuses on a discounted real earnings model, employing a range of optimistic, moderate and pessimistic scenarios. Based on estimates of S&P 500 real earnings growth and an implied earnings discount rate derived from a sample period of January 1974 through June 2014, he finds that: Keep Reading
August 6, 2014 - Bonds, Economic Indicators
A subscriber asked (more than two years ago): “Everyone says I should not invest in bonds today because the interest rate is so low (and inflation is daunting). But real bond returns over the last 30 years are great, even while interest rates are low. Could you analyze why bonds do well after, but not before, 1981?” To investigate, we consider the U.S. long-run interest rate and the U.S. Consumer Price Index (CPI) series from Robert Shiller. The long-run interest rate is the yield on U.S. government bonds, specifically the 10-year U.S. Treasury note (T-note) after 1953. We apply the formula used by Aswath Damodaran to this yield series to estimate the nominal T-note returns. We use the CPI series to calculate the inflation rate. We subtract the inflation rate from the nominal T-note return to get the real T-note return. Using annual Shiller interest rate and CPI data for 1871 through 2013, we find that: Keep Reading
August 5, 2014 - Bonds, Economic Indicators
A reader commented and asked: “A wide credit spread (the difference in yields between Treasury notes or Treasury bonds and investment grade or junk corporate bonds) indicates fear of bankruptcies or other bad events. A narrow credit spread indicates high expectations for the economy and corporate world. Does the credit spread anticipate stock market behavior?” To investigate, we define the credit spread as the difference in yields between and Moody’s seasoned Baa corporate bonds and 10-year Treasury notes (T-note). Using average daily yields for these instruments by calendar month and contemporaneous monthly closes of the S&P 500 Index for April 1953 through June 2014 (735 months), we find that: Keep Reading
July 25, 2014 - Economic Indicators
Many stock market commentators cite Gross Domestic Product (GDP) growth as an indicator of stock market prospects, and the financial media dutifully report advance, preliminary and final U.S. GDP growth rates each month on a quarterly cycle. Does GDP or any of its Personal Consumption Expenditures (PCE), Private Domestic Investment (PDI) and government spending components usefully predict stock market returns? Using quarterly and annual seasonally adjusted nominal (final) GDP data as available from the Bureau of Economic Analysis (BEA) during January 1929 through March 2014 (about 84 years) and contemporaneous levels of the S&P 500 Index (since 1950) and the Dow Jones Industrial Average (DJIA), we find that: Keep Reading
July 22, 2014 - Economic Indicators, Momentum Investing, Size Effect, Value Premium
Do the behaviors of the most widely accepted stock market factors (size, book-to-market or value, and momentum) vary with the economic trend? In the June 2014 version of their paper entitled “Macroeconomic Determinants of Cyclical Variations in Value, Size and Momentum premium in the UK”, Golam Sarwar, Cesario Mateus and Natasa Todorovic examine differences in the sensitivities of UK equity market size, value and momentum factor returns (premiums) to changes in broad and specific economic variables. They define the broad economic state each month as upturn (downturn) when the OECD Composite Leading Indicator for the UK increases (decreases) that month. They also consider contributions of six specific variables to economic trend: GDP growth; unexpected inflation (change in CPI); interest rate (3-month UK Treasury bill yield); term spread (10-year UK Treasury bond yield minus 3-month UK Treasury bill yield); credit spread (Moody’s U.S. BBA yield minus 10-year UK government bond yield); and, money supply growth. They lag economic variables by one or two months to align their releases with stock market premium measurements. Using monthly UK size, value and momentum factors and economic data during July 1982 through December 2012, they find that: Keep Reading