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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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SACEVS Input Risk Premiums and EFFR

The “Simple Asset Class ETF Value Strategy” seeks diversification across a small set of asset class exchanged-traded funds (ETF), plus a monthly tactical edge from potential undervaluation of three risk premiums:

  1. Term – monthly difference between the 10-year Constant Maturity U.S. Treasury note (T-note) yield and the 3-month Constant Maturity U.S. Treasury bill (T-bill) yield.
  2. Credit – monthly difference between the Moody’s Seasoned Baa Corporate Bonds yield and the T-note yield.
  3. Equity – monthly difference between S&P 500 operating earnings yield and the T-note yield.

Premium valuations are relative to historical averages. How might this strategy react to increases in the Effective Federal Funds Rate (EFFR)? Using monthly values of the three risk premiums, EFFR, total 12-month U.S. inflation and core 12-month U.S. inflation during July 2000 (limited by availability of EFFR) through May 2018 (215 months), we find that: Keep Reading

Inflation Forecast Update

The Inflation Forecast now incorporates actual total and core Consumer Price Index (CPI) data for May 2018. The actual total (core) inflation rate for May is higher than (slightly higher than) forecasted.

Unemployment Rate and Stock Market Returns

The financial 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. Conversely, investors may interpret a falling unemployment rate as a trigger for increases in the Federal Reserve target interest rate (and adverse stock market reactions). 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 U.S. Bureau of Labor Statistics (BLS) and contemporaneous S&P 500 Index data for the period January 1950 through April 2018 (820 months), we find that: Keep Reading

Employment and Stock Market Returns

U.S. job gains or losses are a prominent element of the monthly investment-related news cycle, with the financial 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 employment trends in fact predictive of U.S. stock market behavior in subsequent months, quarters and years? Using monthly seasonally adjusted nonfarm employment data from the U.S. Bureau of Labor Statistics (BLS) and contemporaneous S&P 500 Index data for the period January 1950 through April 2018 (820 months), we find that: Keep Reading

Federal Deficit and Stock Returns

Does the level of, or change in, the annual U.S. federal deficit systematically influence the U.S. stock market, perhaps by stimulating consumption and thereby lifting corporate earnings (bullish) or by igniting inflation and thereby elevating discount rates (bearish)? To check, we relate annual stock market returns to the annual surplus/deficit (receipts minus outlays) as a percentage of Gross Domestic Product (GDP). We align stock market returns with deficit calculations (federal fiscal years, FY) 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 surplus/deficit data and returns for the Dow Jones Industrial Average (DJIA) as a proxy for the U.S. stock market during FY 1930 through 2017 (83 years), plus deficit projections through 2023, we find that: Keep Reading

Leading Economic Index and the Stock Market

The Conference Board “publishes leading, coincident, and lagging indexes designed to signal peaks and troughs in the business cycle for major economies around the world,” including the widely cited Leading Economic Index (LEI) for the U.S. Does the LEI predict stock market behavior? Using the as-released monthly change in LEI from archived Conference Board press releases and contemporaneous dividend-adjusted daily levels of SPDR S&P 500 (SPY) for June 2002 through April 2018 (190 monthly LEI observations), we find that: Keep Reading

Expert Estimates of 2018 Country Equity Risk Premiums and Risk-free Rates

What are current estimates of equity risk premiums (ERP) and risk-free rates around the world? In their April 2018 paper entitled “Market Risk Premium and Risk-free Rate Used for 59 Countries in 2018: A Survey”, Pablo Fernandez, Vitaly Pershin and Isabel Acin summarize results of a March 2018 email survey of international finance/economic professors, analysts and company managers “about the Risk Free Rate and the Market Risk Premium (MRP) used to calculate the required return to equity in different countries.” Results are in local currencies. Based on 5,173 specific and credible responses spanning 59 countries with more than five such responses, they find that: Keep Reading

Federal Funds Rate-Stock Market Interactions

A subscriber wondered whether U.S. stock market movements predict Federal Funds Rate (FFR) actions taken by the Federal Reserve open market operations committee. To investigate and evaluate usefulness of findings, we relate three series:

  1. FFR actions per the above source, along with recent and historical committee meeting dates.
  2. S&P 500 Index returns.
  3. Changes in yield for the 10-Year U.S. Constant Maturity Treasury note (T-note).

In constructing the first series, for Federal Reserve open market operations committee meeting dates which do not produce FFR changes, we quantify committee actions as 0%. We ignore committee conference calls that result in no changes in FFR. We calculate the second and third series between committee meeting dates because that irregular interval represents new information to the committee and potential exploitation points for investors. Using data for the three series during January 1990 through March 2018, we find that:

Keep Reading

GDP Growth and Stock Market Returns

The U.S. Bureau of Economic Analysis (BEA) each quarter estimates economic growth via changes in Gross Domestic Product (GDP) and its Personal Consumption Expenditures (PCE), Private Domestic Investment (PDI) and government spending components. BEA releases advance, preliminary and final data about one, two and three months after quarter ends, respectively. Do these estimates of economic growth usefully predict stock market returns? To investigate, we relate economic growth metrics to future stock market index 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 2017 (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

EFFR and the Stock Market

Do changes in the Effective Federal Funds Rate (EFFR), the actual cost of short-term liquidity derived from a combination of market demand and Federal Reserve open market operations designed to maintain the Federal Funds Rate (FFR) target, predictably influence the U.S. stock market over the intermediate term? To investigate, we relate smoothed (volume-weighted median) monthly levels of EFFR to monthly U.S. stock market returns (S&P 500 Index or Russell 2000 Index) over available sample periods. Using monthly data as specified since July 1954 for EFFR and the S&P 500 Index (limited by EFFR) and since September 1987 for the Russell 2000 Index, all through January 2018, we find that: Keep Reading

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