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.
Employment and Stocks Over the Intermediate Term August 9, 2011
U.S. job gains or losses are a prominent element of the monthly investment-related news cycle, with the 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 these data in fact predictive of U.S. stock market behavior in subsequent months, quarters and years? Using monthly seasonally adjusted nonfarm employment data 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…
Federal Deficit and Stock Returns August 1, 2011
Does the level of the U.S. federal deficit systematically influence stock returns, perhaps by stimulating consumption and thereby lifting corporate earnings (bullish) or by igniting inflation and thereby elevating discount rates (bearish)? To check, we compare stock returns to the deficit (receipts minus outlays) as a percentage of Gross Domestic Product (GDP). We align stock returns with deficit calculations (federal fiscal years) as follows: (1) prior to 1977, we calculate annual returns from July through June; (2) we ignore the July 1976 through September 1976 transition quarter; and, (3) since 1977, we calculate annual returns from October through September. Using fiscal year deficit data and fiscal year returns for the Dow Jones Industrial Average (DJIA) during the 81-year period 1930-2010 (with 2010 estimated), we find that: More…
Do Copper Prices Lead the Broad Equity Market? July 21, 2011
A reader asked: “Do copper futures reliably lead the market, as some believe.” The hypothesis is that demand for copper is a reliable leading indicator of economic activity and therefore of future corporate earnings reports and equity prices. In lieu of a long-run set of copper futures data, we use the monthly price index for copper base scrap (not seasonally adjusted) from the “Metal and Metal Products” group of the Producer Price Index components. This series is much longer than those for other copper proxies, extending back to the beginning of 1957, thereby enabling analyses across multiple economic expansions and contractions. Using the monthly copper scrap price index and monthly levels of the S&P 500 Index for January 1957 through June 2011 (654 months), we find that: More…
Credit as a Tactical Asset Allocation Signal June 29, 2011
Does the claim that “credit anticipates and equity confirms” support a trading strategy? In his June 2011 paper entitled “Credit-Informed Tactical Asset Allocation”, David Klein tests a stocks-cash allocation strategy that derives signals from relative valuation of the Bank of America/Merrill Lynch High Yield B index (converted to a default probability) and the Russell 2000 Index (with dividends). The basic premises for the strategy are: (1) stock prices tend to fall when credit spreads rise; and, (2) small capitalization stocks are more sensitive to the credit cycle than large capitalization stocks. The execution of the strategy is to hold stocks (short-term Treasuries) when stocks appear undervalued (overvalued) relative to corporate bonds based on data from a rolling six-month historical interval. Using daily data for the two indexes during May 1997 through April 2011, he finds that: More…
ADP Employment Report and Stock Returns June 27, 2011
Since May 2006, the monthly ADP National Employment Report has presented “estimates of nonfarm private employment…constructed from ADP’s data on payrolls following a procedure similar to that used by the BLS [Bureau of Labor Statistics] to process its monthly survey of Current Employment Statistics into the ‘official’ estimates of establishment employment. The ADP National Employment Report is released, for public use only, two days prior to the Employment Situation.” Does this report affect or predict U.S. stock market returns on the day of release or during the ensuing month? Using ADP report release dates and estimates of total nonfarm employment for April 2006 through May 2011 (62 months) and contemporaneous daily and monthly dividend-adjusted levels of S&P Depository Receipts (SPY), we find that: More…
Probability of Recession and Future Stock Returns June 14, 2011
Some time ago, a reader suggested: “Political Calculations has a tool to ‘reckon the odds of U.S. recession in the next 12 months’ based on a formula developed by the Econobrowser from a paper entitled ‘The Yield Curve and Predicting Recessions’ by the Federal Reserve Board’s Jonathan Wright. What about looking at it the other way in trying to gauge the odds of recovery using the tool?” Focusing on the usefulness of the yield curve-based Wright Model (WM) for predicting stock market behavior, we relate its outputs to future stock market returns. Using monthly closes for the 10-year Treasury note yield, the 13-week Treasury bill (T-bill) yield, the Federal Funds Rate (FFR) and dividend-adjusted S&P 500 Depository Receipts (SPY) over the period January 1993 (SPY inception) through May 2011 (221 months), we find that: More…
ECRI’s Weekly Leading Index and the Stock Market June 13, 2011
Financial market commentators and media sometimes cite the Economic Cycle Research Institute’s (ECRI) Weekly Leading Index (WLI) as an important economic indicator, implying that it is somehow predictive of future stock market performance. According to ECRI, WLI “[h]as a moderate lead over U.S. business cycle.” 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 May 2011 (2,317 weeks) and contemporaneous weekly levels of the S&P 500 Index, we find that: More…
Does a Weak Dollar Favor Large Capitalization Stocks? June 10, 2011
When the dollar weakens, large capitalization U.S. firms may benefit from their international footprints, generating substantial revenues around the globe in local currencies and converting those revenues into an increased number of dollars on their income statements. Should investors therefore shift toward (away from) large capitalization stocks when the dollar weakens (strengthens)? To check, we compare the performance of the Dow Jones Industrial Average (DJIA) (representing internationally positioned, large capitalization stocks) and the Russell 2000 Index (representing small capitalization stocks) during and after the dollar trends against the euro. We focus on non-overlapping three-month measurement intervals to match corporate earnings release frequency. Using data for the stock indexes and the dollar-euro exchange rate over the period January 2000 through May 2011 (about 45 quarters), we find that: More…
Dollar-Euro Exchange Rate and U.S. Stocks June 10, 2011
Whenever the dollar-euro exchange rate exhibits a trend, experts theorize. A falling dollar is good because U.S. exports boom and domestic employment rises. Or, a falling dollar is bad because capital flees the U.S., and import prices spur inflation. Are there reliable and exploitable relationships between the dollar-euro exchange rate and U.S. stocks? To check, we apply regressions and rankings to characterize the short-term and intermediate-term interactions between the exchange rate and the stock market. Using daily data for the dollar-euro exchange rate and the S&P 500 Index over the period January 2000 through May 2011 (about 572 weeks or 44 quarters), we find that: More…
POMO and T-note Yield May 25, 2011
The Federal Reserve states that open market operations regulate “the aggregate level of balances available in the banking system,” thereby keeping the effective Federal Funds Rate close to a target level. The operations are predominantly repurchases, whereby the Federal Reserve provides liquidity. Do Permanent Open Market Operations (POMO) systematically affect the nominal or real yields on 10-year Treasury notes (T-notes)? Using data for accepted Treasuries repurchases via POMO during August 2005 through May 2011 to date (323 transactions over 70 months, with May 2011 a partial month) and contemporaneous monthly T-note yields and lagged inflation rates, we find that: More…
