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 April 2016. The actual total (core) inflation rate for April is higher than (about the same as) forecasted.

Credit Spread as a Stock Market Indicator

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 (a smoothed measurement) and contemporaneous monthly closes of the S&P 500 Index for April 1953 through March 2016 (756 months), we find that: Keep Reading

Stock Returns on Days of Unemployment Claims Reports

Each week the financial media report U.S. initial and continued unemployment claims (seasonally adjusted) as a potential indicator of future U.S. stock market returns. Do these indicators move the market? To investigate, we focus on weekly changes in unemployment claims during a period of “modern” information dissemination to release-day stock market returns. A modern period arguably encompasses the history of S&P Depository Receipts (SPY), a proxy for the U.S. stock market. Using relevant news releases and archival data as available from the Department of Labor (DOL) and daily unadjusted opening and closing levels for SPY during late January 1993 through mid-April 2016 (1,212 weeks), we find that: Keep Reading

Enhancing Stock Market Prediction with Distilled Economic Variables

Can investors exploit economic data for monthly stock market timing? In their September 2015 paper entitled “Getting the Most Out of Macroeconomic Information for Predicting Excess Stock Returns”, Cem Cakmaklı and Dick van Dijk test whether a model employing 118 economic variables improves prediction of monthly U.S. stock market (S&P 500 Index) excess returns based on conventional valuation ratios (dividend yield and price-earnings ratio) and interest rate indicators (risk-free rate, change in risk-free rate and credit spread). Excess return means above the risk-free rate. They each month apply principal component analysis to distill from the 118 economic variables (or from subsets of these variables with the most individual power to predict S&P 500 Index returns) a small group of independent predictive factors. They then regress next-month S&P 500 Index excess returns linearly on these factors and conventional valuation ratios/interest rate indicators over a rolling 10-year historical window to generate excess return predictions. They measure effectiveness of the economic inputs in two ways:

  1. Directional accuracy of forecasts (proportion of forecasts that accurately predict the sign of next-month excess returns).
  2. Explicit economic value of forecasts via mean-variance optimal stocks-cash investment strategies that each month range from 200% long to 100% short the stock index depending on monthly excess return predictions as specified and monthly volatility predictions based on daily index returns over the past month, with transaction costs of 0.0%, 0.1% or 0.3%.

Using monthly values of the 118 economic variables (lagged one month to assure availability), conventional ratios/indicators and monthly and daily S&P 500 Index levels during January 1967 through December 2014, they find that: Keep Reading

ISM NMI and Stock Returns

Each month, the Institute for Supply Management (ISM) compiles results of a survey “sent to more than 375 purchasing executives working in the non-manufacturing industries across the country.” Based on this survey, ISM computes the Non-Manufacturing Index (NMI), “a composite index based on the diffusion indexes for four…indicators with equal weights: Business Activity (seasonally adjusted), New Orders (seasonally adjusted), Employment (seasonally adjusted) and Supplier Deliveries.” ISM releases NMI for a month on the third business day of the following month. Does the monthly level of NMI or the monthly change in NMI predict U.S. stock market returns? Using monthly NMI data and monthly closes of the S&P 500 Index from January 2008 through January 2016 (97 months), we find that: Keep Reading

ISM PMI and Stock Returns

According to the Institute for Supply Management (ISM) ISM, their Manufacturing Report On Business, published since 1931, “is considered by many economists to be the most reliable near-term economic barometer available.” The manufacturing summary component of this report is the Purchasing Managers’ Index (PMI), aggregating monthly inputs from purchasing and supply executives across the U.S. regarding new orders, production, employment, deliveries and inventories. ISM releases PMI for a month at the beginning of the following month. Does PMI, as claimed by some financial experts, predict stock market returns? Using monthly seasonally adjusted PMI data and monthly S&P 500 Index closes from January 1950 through January 2016 (793 months), we find that: Keep Reading

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 economic experts the probabilities of U.S. economic recession (negative GDP growth) during each of the next four quarters. The survey report release schedule is mid-quarter. For example, the release date of the survey report for the first quarter of 2016 is February 12, 2016, with forecasts for the second quarter of 2016 through the first quarter of 2017. The “Anxious Index” is the probability of recession during the next quarter. When professional forecasters are relatively optimistic (pessimistic) about the economy, does the stock market go up (down) over the coming quarters? Using survey results and quarterly S&P 500 Index levels (measured in the middle of calendar quarters to approximate release dates of survey results) from the fourth quarter of 1968 through the first quarter of 2016 (190 surveys), 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 January 2016 and contemporaneous weekly levels of the S&P 500 Index, we find that: Keep Reading

Economic News Leaks to Some Traders?

Can small (unconnected) investors compete in trades on economic news? In the February 2016 draft of her paper entitled “Is Someone Front-Running You Around News Releases?”, Irene Aldridge examines U.S. stock price, volatility and trading activity around ISM Manufacturing Index and Construction Spending news releases (which occur while the stock market is open). Media violations of embargoes on pre-release distribution of such news, intended to promote widespread simultaneous scheduled release, could influence this activity. She uses average price response of Russell 3000 stocks as a market reaction metric. She considers news “direction” relative either to prior-month value (increase or decrease) or to consensus forecast (above or below). Using one-minute trading data for Russell 3000 Index stocks around monthly ISM Manufacturing Index and Construction Spending announcements during January 2013 through October 2015, she finds that: Keep Reading

GDP Growth and Stock Market Returns

Many stock market commentators cite Gross Domestic Product (GDP) growth from the Bureau of Economic Analysis (BEA) 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 growth in 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 GDP data from BEA National Income and Product Accounts Table 1.1.5 as available during January 1929 through December 2015 (about 87 years) and contemporaneous levels of the S&P 500 Index (since 1950 only) and the Dow Jones Industrial Average (DJIA), we find that: Keep Reading

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