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Disposable Income and the Stock Market

July 17, 2013 • Posted in Economic Indicators

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 27 of Table 2.6, “Personal Income and Its Disposition, Monthly.” Using this series for January 1959 through May 2013 and contemporaneous monthly levels of the S&P 500 Index (through June 2013), we find that…

The following chart compares the behaviors of the S&P 500 Index and DPI, both on logarithmic scales, over the entire sample period. Although both series generally rise over time, the large mismatch in volatilities makes it very difficult to discern any exploitable relationship between them.

For a closer look, we relate monthly changes in the two series.

SP500-DPI

The next chart shows Pearson correlations for various lead-lag scenarios between monthly changes in DPI and monthly S&P 500 Index returns, ranging from the stock market leads DPI by 12 months (-12) to DPI leads the stock market by 12 months (12), both for the entire sample period and a recent subperiod. Correlations are small and noisy, with little or no evidence that either series materially leads the other.

In case there is a longer-term relationship, we relate quarterly changes?

DPI-SP500-leadlag-monthly

The next chart shows Pearson correlations for various lead-lag scenarios between quarterly changes in DPI and quarterly S&P 500 Index returns, ranging from the stock market leads DPI by six quarters (-6) to DPI leads the stock market by six quarters (6), over the entire sample period. While correlations are not large, it appears that:

  • A relatively strong (weak) stock market over the past four quarters has some positive (negative) effect on future DPI.
  • Relatively strong (weak) growth in DPI over the past four quarters has some negative (positive) effect on the stock market.

Because the relationship appears to be multi-quarter, we look at annual correlations.

DPI-SP500-leadlag-quarterly

The next chart shows Pearson correlations for various lead-lag scenarios between annual changes in DPI and annual S&P 500 Index returns, ranging from the stock market leads DPI by four years (-4) to DPI leads the stock market by four years (4), over the entire sample period. While correlations are noisy rather than compelling, results do not contradict the above findings.

A possible interpretation is that DPI (post-tax income) reacts slowly to economic development, while financial markets react quickly. 

DPI-SP500-leadlag-annual

In summary, evidence from simple tests weakly supports beliefs that changes in Disposable Personal Income: (1) do not usefully predict stock market returns at a monthly horizon; and, (2) may be slightly contrarian at quarterly and annual horizons.

Cautions regarding findings include:

  • As noted, correlations are generally weak and noisy, undermining confidence in findings.
  • Analyses are in-sample and findings may differ for extended subperiods.
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