Economic Indicators

The Inflation Forecast now incorporates actual total and core Consumer Price Index (CPI) data for September 2024. The actual total (core) inflation rate is a little lower than (a little higher than) forecasted.

What variables best explain increases and decreases in Cyclically Adjusted Price-to-Earnings ratio (CAPE or P/E10)? In their August 2024 paper entitled “Analyzing Changing ‘Investor Exuberance’: The Determinants of S&P Composite Index Total Return CAPE Changes”, C. Krishnan, Jiemin Yang and Xiyao Tan apply the following three techniques to investigate which of 42 potentially explanatory variables relate most strongly to changes in CAPE:

1. Linear regression with principal component analysis.
2. Least Absolute Shrinkage and Selection Operator (LASSO) regression analysis, which shrinks some regression coefficients to zero, thereby identifying the most important independent variables.
3. Elastic net, which combine approaches of LASSO and Ridge regression to distill the most important independent variables.

Using monthly values for CAPE and the 42  potentially explanatory variables during February 2000 through December 2019, they find that: Keep Reading

How do returns of different asset classes recently interact with the Effective Federal Funds Rate (EFFR)? We focus on monthly changes (simple differences) in EFFR  and look at lead-lag relationships between change in EFFR and returns for each of the following 10 exchange-traded fund (ETF) asset class proxies:

• Equities:
  • SPDR S&P 500 (SPY)
  • iShares Russell 2000 Index (IWM)
  • iShares MSCI EAFE Index (EFA)
  • iShares MSCI Emerging Markets Index (EEM)
• Bonds:
  • iShares Barclays 20+ Year Treasury Bond (TLT)
  • iShares iBoxx $ Investment Grade Corporate Bond (LQD)
  • iShares JPMorgan Emerging Markets Bond Fund (EMB)
• Real assets:
  • Vanguard REIT ETF (VNQ)
  • SPDR Gold Shares (GLD)
  • Invesco DB Commodity Index Tracking (DBC)

Using end-of-month EFFR and dividend-adjusted prices for the 10 ETFs during December 2007 (limited by EMB) through August 2024, we find that: Keep Reading

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 horizons up to a few months? 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 August 2024, we find that: Keep Reading

How do crypto-asset prices interact with conventional market risks, monetary policy and crypto-specific factors? In their July 2024 paper entitled “What Drives Crypto Asset Prices?”, Austin Adams, Markus Ibert and Gordon Liao investigate factors influencing crypto-asset returns using a sign-restricted, structural vector auto-regressive model. Specifically, they decompose daily Bitcoin returns into components reflecting:

• Monetary policy – estimated from effects of changes in the short-term risk-free rate on crypto-asset prices.
• Conventional risk premiums – estimated from daily interactions of 2-year zero coupon U.S. Treasury notes (T-notes) and the S&P 500 Index to account for changes in risk compensation required for holding traditional financial assets.
• Crypto risk premium – estimated from variations in the risk compensation demanded
  by investors for holding crypto assets as indicated by crypto-asset market liquidity and volatility.
• Level of crypto adoption – estimated from co-movements of Bitcoin and stablecoin market capitalizations to reflect crypto-asset innovation, regulatory changes and sentiment shifts.

Using daily data for the risk-free rate, S&P 500 Index, T-notes, Bitcoin and two stablecoins (USDT and USDC), during January 2019 through February 2024, they find that: Keep Reading

Is copper price a reliable leading indicator of economic activity and therefore of future corporate earnings and equity prices? To investigate, we employ the monthly price index for copper base scrap from the U.S. Bureau of Labor Statistics, which spans multiple economic expansions and contractions. Using monthly levels of the copper scrap price index and the S&P 500 Index during January 1957 through May 2024, we find that: Keep Reading

Is the Buffett Indicator, the ratio of total U.S. stock market capitalization (proxied by Wilshire 5000 Total Market Index W5000) to U.S. Gross Domestic Product (GDP), a useful indicator of future U.S. stock market performance? W5000/GDP clearly has no stable average value over its available history (see the first chart below), so the level of the ratio is not a useful predictor. We therefore consider the following variables based on W5000/GDP as predictors of W5000 returns at horizons up to two years:

1. Quarterly change in W5000/GDP.
2. Average quarterly change in W5000/GDP over the past two years (eight quarters).
3. Average quarterly change in W5000/GDP over the past five years (20 quarters).
4. Slope of W5000/GDP over the past two years.
5. Slope of W5000/GDP over the past five years.

We consider two kinds of tests: (1) a linear test relating past changes in these variables to future W5000 returns up to two years; and, (2) a non-linear test calculating average next-quarter W5000 returns by ranked fifths (quintiles) of past changes in these variables. Using quarterly levels of W5000 (with extension), Shiller’s P/E10 lagged by one quarter and quarterly GDP lagged by one quarter during the first quarter of 1971 through the first quarter of 2024, we find that: Keep Reading

A subscriber noted and asked: “Michigan (at one point) claimed that the inflation expectations part of their survey of consumers was predictive. That was from a paper long ago. I wonder if it is still true.” To investigate, we relate monthly “Expected Changes in Prices” (expected annual inflation) from the monthly University of Michigan Survey of Consumers and actual U.S. inflation data based on the monthly non-seasonally adjusted consumer price index (U.S. city average, All items). The University of Michigan releases final survey data near the end of the measured month. We consider two relationships:

• Expected annual inflation versus one-year hence actual annual inflation.
• Monthly change in expected annual inflation versus monthly change in actual annual inflation.

As a separate (investor-oriented) test, we relate monthly change in expected annual inflation to next-month total returns for SPDR S&P 500 ETF Trust (SPY) and iShares 20+ Year Treasury Bond ETF (TLT). Using monthly survey/inflation data since January 1978 (limited by survey data) and monthly SPY and TLT total returns since July 2002 (limited by TLT), all through April 2024, we find that: Keep Reading

In response to “Money Supply (M2) and the Stock Market”, a subscriber commented: “I’ve always thought…that both M2 and velocity were needed. If there’s more money, but it is not circulating, then it doesn’t have a chance to have much impact. That’s the situation we have right now for the most part.” The Federal Reserve Bank of St. Louis tracks money velocity based either M1 or M2 money supply at a quarterly frequency, stating that: “Velocity is a ratio of nominal GDP to a measure of the money supply. It can be thought of as the rate of turnover in the money supply–that is, the number of times one dollar is used to purchase final goods and services included in GDP.” Specifically, the bank calculates money velocity as quarterly nominal GDP divided by average money supply during the quarter. Using quarterly and seasonally adjusted Velocity of M1, Velocity of M2 and S&P 500 Index (SP500) level during the first quarter of 1959 through the first quarter of 2024, we find that: Keep Reading

in response to “Money Supply (M2) and the Stock Market”, A reader commented: “M2 cannot be an accurate money supply measure because it includes non-cash investments such as money market mutual funds. When the stock market corrects and people are exchanging stocks for say, money market mutual fund shares, the M2 figure will actually increase. The money supply is not literally increasing in such cases as no new cash is being created; there is merely an exchange of existing assets. Technically, only increasing the monetary base would increase the money supply, but M1 is a reasonable substitute for that as it includes the cash part of bank reserves.” The M1 money stock consists of funds that are readily accessible for spending: currency in circulation, traveler’s checks, demand deposits and other checkable deposits. Is there a reliable relationship between historical variation in M1 and future stock market returns? Using monthly data for seasonally adjusted M1 and the S&P 500 Index (SP500) during January 1959 through April 2024, we find that: Keep Reading