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, with consideration of the lengths of data series available, we define the credit spread as the difference in yields between 10-year Treasury notes (T-note) and Moody’s seasoned Baa corporate bonds. Using average monthly yields for these instruments and contemporaneous monthly levels of the S&P 500 Index for April 1953 through August 2010 (689 months), we find that: More…

Conventional wisdom holds that a steep yield curve (U.S. Treasuries term spread) is good for stocks, while a flat/inverted curve is bad. Is this wisdom correct? Using average monthly yields  for 90-day Treasuries (T-bill),  1-year Treasuries,  3-year Treasuries, 5-year Treasuries, 10-year Treasuries (T-note) and 20-year Treasuries and contemporaneous monthly levels of the S&P 500 Index for April 1953 through August 2010 (689 months, with 81 of these months not available for 20-year Treasuries), we find that: More…

Can investors anticipate long-term changes in the interest rate environment accurately enough to support active management of bond portfolios? In their September 2010 paper entitled “Gains from Active Bond Portfolio Management Strategies”, Naomi Boyd and Jeffrey Mercer investigate the effectiveness of using Federal Reserve policy signals for two types of bond allocation timing strategies: (1) increasing (decreasing) portfolio duration in anticipation of rate decreases (increases); and, (2) anticipating narrowing or widening of the yield spreads between categories of bonds with different credit ratings. They assume that a falling (rising) interest rate interval begins the month after an Federal Open Market Committee (FOMC) bank discount rate decrease (increase) that follows an increase (a decrease) and ends the month after the next discount rate increase (decrease). Using FOMC announcements and monthly total returns for U.S. 30-day Treasury Bill (T-bill), U.S. Intermediate-term Government Bond, U.S. Long-term Government Bond, U.S. Long-term Corporate Bond and Domestic High-yield Corporate Bond indexes spanning 1973-2006, they find that: More…

The Mojena Market Timing model, developed and maintained by retired professor Richard Mojena, is a method for timing the broad U.S. stock market based on a combination of 11 monetary, fundamental, technical and sentiment indicators to predict changes in intermediate-term and long-term market trends. He adjusts the model annually to incorporate new data year by year. Professor Mojena offers a hypothetical backtest of the timing model since 1970 and a live investing test since 1990 based on the S&P 500 Index (with dividends). To test the robustness of his model’s performance, we consider a sample period bounded by the availability of Standard and Poor’s Depository Receipts (SPY) as a conveniently investable proxy for the S&P 500 Index. As benchmarks, we consider both buying and holding SPY and trading SPY based on the 10-month simple moving average (SMA) of the S&P 500 Index. Using the trade dates from the Mojena Market Timing live test, daily dividend-adjusted closes for SPY and daily yields for 13-week Treasury bills (T-bills) over the period 1/29/93 through 8/27/10 (nearly 18 years), we find that: More…

Do investors view industrial metal price changes differently during good times and bad times? In the August 2010 draft of their paper entitled “Return Predictability When News Means Different Things in Different Times”, Ben Jacobsen, Ben Marshall and Nuttawat Visaltanachoti explore how the power of aluminum, copper, lead, nickel and zinc price changes to predict stock returns differs between economic expansions and contractions. For the U.S., they consider two indicators of the economic state, NBER business cycles and the Chicago Fed National Activity Index. Using futures prices for aluminum, copper, nickel, lead and zinc since 1991, 1977, 1995, 1977 and 1991, respectively, levels of the Goldman Sachs industrial metal index since 1977 and contemporaneous data for the S&P 500 Index and 13 economic indicators through June 2010, they find that: More…

A reader asked: “Is disposable income a leading indicator of the stock market?” Arguably, an increase in disposable income would lead to growth in consumption, corporate earnings and stock valuation. The Bureau of Economic Analysis releases seasonally adjusted Disposable Personal Income (DPI) monthly with a lag of about one month via Line 22 of Table 2.6, “Personal Income and Its Disposition, Monthly.” Using this series and S&P 500 Index data for January 1959 through June 2010 (618 months), we find that… More…

A reader, citing the book Ahead of the Curve by Joseph Ellis, inquired about the hypothesis that consumer spending drives economic cycles and is therefore a leading indicator for the stock market. For example, Mr. Ellis presents a chart relating quarterly annualized change in Personal Consumption Expenditures (PCE) to quarterly change in the S&P 500 Index and states: “Most bear markets…proceed as (the rate of growth in) consumer spending continues to slow, and are largely over by the time recessions…are under way. Conversely, most bear markets end…when consumer spending and S&P 500 profits are at, or even prior to, their worst Y/Y comparisons.” Does PCE usefully predict stock market behavior? The Bureau of Economic Analysis releases seasonally adjusted PCE monthly with a lag of about one month via Line 24 of Table 2.6, “Personal Income and Its Disposition, Monthly.” Using this series and S&P 500 Index data for January 1959 through June 2010 (618 months), we find that… More…

Some investing experts cite consumer credit as a potentially important indicator of future stock market behavior, hypothesizing that an expansion (contraction) in credit indicates growing (shrinking) corporate sales, earnings and ultimately stock prices. Is there a reliable relationship between historical variation in consumer credit and stock market returns? The Federal Reserve collects and publishes U.S. consumer credit data on a monthly basis with a delay of about five weeks. Using monthly seasonally adjusted total U.S. consumer credit data for January 1950 through May 2010 and monthly S&P 500 Index closes for January 1950 through June 2010 (725-726 months), we find that: More…

A reader asked: “I would really appreciate your review of “S&P 500 Returns Revisited”. It seems crazy…but crazy enough to work?” This March 2010 paper, one of 46 currently in the Social Science Research Network by one or both of Ivan Kitov and Oleg Kitov, presents an abstract as follows:

“The predictions of the S&P 500 returns made in 2007 have been tested and the underlying models amended. The period between 2003 and 2008 should be described by the dependence of the S&P 500 stock market index on real GDP because the population pyramid was highly inaccurate. The 2008 trough and 2009 rally are well predicted by the original model, however. The rally will end in March/April 2010 and the S&P 500 level will be decreasing into 2011. This prediction should validate the model.”

This paper aims to predict the behavior of the S&P 500 Index based on very specific short-term demographic variations, purported to indicate changes in economic activity as measured by real Gross Domestic Product (GDP) via GDP per capita. The abstract states that the demographic model does not work well between 2003 and 2008 (because of inaccurate population data), but that a correct prediction from this model for the balance of 2010 into 2011 “should validate the model.” Some observations about this study are: More…

A reader noted and asked: “In a recent article at MarketWatch, Michael Kahn claims that utilities have bond-like sensitivity to interest rates, with the advice that ‘cutting back on exposure to utilities…makes sense, despite their high dividend payouts.’ Do you agree?” To check, we consider the Utilities Select Sector SPDR (XLU) as a proxy for utilities and both 10-year Treasury note (T-note) and 13-week Treasury bill (T-bill) yields as proxies for long-term and short-term interest rates, respectively. Using weekly, monthly and quarterly closing levels of dividend-adjusted XLU, dividend-adjusted S&P 500 SPDR (SPY), T-note yield and T-bill yield over the period December 1998 (limited by XLU inception) through March 2010, we find that: More…