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.
When and Why of the Size Effect November 14, 2011
Does the size effect vary in an usefully predictable way? In the October 2011 revision of his paper entitled “Predicting the Small Stock Premium Over Different Horizons: What Do We Learn About Its Source?”, Valeriy Zakamuline examines whether eight U.S. market/economic variables exploitably predict the small stock premium at monthly, quarterly, semiannual and annual horizons. The eight variables are: (1) stock market return; (2) stock market dividend yield; (3) equity value premium; (4) stock return momentum; (5) default spread (Moody’s BAA-AAA corporate bond yield spread); (6)one-month Treasury bill yield; (7) U.S. Treasuries term premium (30-year bond yield minus one-month bill yield); and, (8) inflation rate. Using monthly data for the potentially predictive variables and for a broad sample of U.S. stocks/firms during January 1927 through December 2010 (1008 months, 252 quarters and 84 years), he finds that: More…
Size Effect and the Economy October 12, 2011
Does the size effect vary with the state of the economy? In his October 2010 paper entitled “The Behaviour of Small Cap vs. Large Cap Stocks in Recessions and Recoveries: Empirical Evidence for the United States and Canada”, Lorne Switzer examines the relative performance of small versus large capitalization stocks around economic peaks and troughs (per NBER business cycle data). Using monthly returns for U.S. (Canadian) stocks starting with January 1926 (1987), associated firm characteristics and contemporaneous economic and equity market benchmark data through August 2010, he finds that: More…
The Decision Moose Asset Allocation Framework October 7, 2011
A reader suggested a review of the Decision Moose asset allocation framework of William Dirlam. “Decision Moose is an automated framework for making intermediate-term investment decisions.” Decision Moose focuses on asset class momentum, as augmented by monetary policy, exchange rate and interest rate indicators. Its signals tell followers when to switch from one index fund to another among nine encompassing a broad range of asset classes, including equity indexes for several regions of the globe. The trading system is a long-only approach that allocates 100% of funds to the index “having the highest probability of price appreciation.” The site includes a history of switch recommendations since the end of August 1996, with gross performance. To evaluate Decision Moose, we assume that the 69 switches and associated trading returns are as described (out of sample, not backtested) and compare the returns to those for the dividend-adjusted S&P 500 Depository Receipts (SPY) over the same intervals. Using data for the 69 trades spanning 8/30/96 through 9/23/11 (15 years), we find that: More…
Should the “Anxious Index” Make Investors Anxious? September 23, 2011
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 for 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 quarters? Using survey results and quarterly S&P 500 Index data from the fourth quarter of 1968 through the second quarter of 2011 (171 surveys), we find that: More…
FOMC Drives Global Equity Markets? September 16, 2011
Does anticipation of Federal Open Market Committee (FOMC) monetary policy announcements move the market? Is any such anticipation permanent? In their September 2011 paper entitled “The Pre-FOMC Announcement Drift”, David Lucca and Emanuel Moench investigate the short-term effects of FOMC announcements on global equity markets. They focus on the U.S. stock market during the 24-hour interval from 2 PM on the day before to 2 PM on the day of scheduled FOMC announcements. Using FOMC announcement dates and intraday returns for the S&P 500 Index, other major stock market indexes and other asset classes, and daily returns for individual U.S. stocks and 49 industries, during February 1994 through March 2011 (138 scheduled FOMC meetings), they find that: More…
Trade the Ten O’Clock News? September 7, 2011
Can traders reliably play price jumps associated with surprising economic news releases? In their September 2011 paper entitled “Information Driven Price Jumps and Trading Strategy: Evidence from Stock Index Futures”, Hong Miao, Sanjay Ramchander and Kenton Zumwalt examine the relationship between surprises in announcements for eight U.S. macroeconomic indicators and jump returns for Dow Jones Industrial Average (DJIA), NASDAQ Composite Index and S&P 500 Index futures. They define surprises for each economic indicator based on “standardized” values defined as the gap between actual values and consensus forecasts divided by the standard deviation of gaps. They test the profitability of a high-frequency trading strategy constructed to exploit the surprise-jump relationship for 10:00 AM announcements via nearest index futures contracts, taking one-minute long (short) positions during 10:01-10:02 AM after positive (negative) surprises. When there are multiple 10:00 AM announcements, trades trigger only if all surprises have the same direction. They assume trading friction of one tick for each one-way transaction. Using tick-by-tick nearest or next-nearest to maturity (depending on volume) futures contract prices and pre-announcement consensus (median) forecasts and actual values for monthly macroeconomic indicators during 2001 through 2010, they find that: More…
Gold Price Drivers? August 18, 2011
What drives the price of gold: inflation, stock prices, public sentiment? To investigate, we relate spot gold price to the Consumer Price Index (non-seasonally adjusted), the S&P 500 Index and consumer sentiment. We start sampling in 1975 because: “On March 17, 1968, …the price of gold on the private market was allowed to fluctuate…[, and] in 1975…the price of gold was left to find its free-market level.” Using monthly data from January 1975 (January 1978 for consumer sentiment) through July 2011 (439 months), we find that: More…
KCFSI as a Stock Market Return Predictor August 15, 2011
A subscriber suggested the Kansas City Financial Stress Index (KCFSI) as a potential stock market return predictor. This index “is a monthly measure of stress in the U.S. financial system based on 11 financial market variables. A positive value indicates that financial stress is above the long-run average, while a negative value signifies that financial stress is below the long-run average. Another useful way to assess the current level of financial stress is to compare the index to its value during past, widely recognized episodes of financial stress.” The paper “Financial Stress: What Is It, How Can It Be Measured, and Why Does It Matter?” describes the 11 financial inputs for KCFSI and its methodology, which involves principal component analysis and normalization. Is it useful for U.S. stock market investors ? To investigate, we relate S&P 500 Index and SPDR S&P 500 (SPY) returns to values of KCFSI. Since KCFSI releases occur about eight days after ends of measured months, we use stock market data for the close on the eighth of each month (or the next trading day if the eighth is not a trading day). Using monthly data for KCFSI, the S&P 500 Index and SPY (starting January 1993) over the period February 1990 through July 2001 (258 months), we find that: More…
Shipping Rates and Stock Market Returns August 12, 2011
Do international (seaborne) shipping rates offer advance information about stock market behavior? In the July 2011 draft of their paper entitled “Stock Market Returns and Shipping Freight Market Information: Yet Another Puzzle!”, Amir Alizadeh and Gulnur Muradoglu examine whether changes in the Baltic Exchange Dry Bulk Freight Index (BDI) predict stock market returns and compare its predictive power to that of West Texas Intermediate (WTI) crude oil. To investigate economic significance, they test three trading strategies: (1) a Long‐Short strategy that is long (short) stocks when the next-period return forecast is positive (negative); (2) a Long Only strategy that is long stocks (in U.S. Treasury bills) when the next-period return forecast is positive (negative); and, (3) a Short Only strategy that is short stocks (in U.S. Treasury bills) when the next-period return forecast is negative (positive). Using monthly data for BDI, WTI crude oil price, 13 U.S. stock size/sector indexes, 29 international stock market indexes and economic indicators over the period January 1989 (the earliest consistent BDI meaurement) through December 2010, they find that: More…
Unemployment Rate and Stock Returns August 11, 2011
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. 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 Bureau of Labor Statistics and contemporaneous S&P 500 Index data for the period January 1950 through July 2011 (739 months), we find that: More…
