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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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Economic Policy Uncertainty and the Stock Market

Does quantified uncertainty in government economic policy reliably predict stock market returns? To investigate, we consider the U.S. Economic Policy Uncertainty (EPU) Index, created by Scott Baker, Nicholas Bloom and Steven Davis and constructed from three components: (1) coverage of policy-related economic uncertainty by prominent newspapers: (2) the number of temporary federal tax code provisions set to expire in future years; and, (3) the level of disagreement in one-year forecasts among participants in the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters for both (a) the consumer price index (CPI) and (b) purchasing of goods and services by federal, state and local governments. They first normalize each component by its own standard deviation prior to January 2012. They then compute a weighted average of components, assigning a weight of one half to news coverage and one sixth each to tax code uncertainty, CPI forecast disagreement and government purchasing forecast disagreement. They update the EPU index monthly with a delay of about one month, including revisions to recent months. Using monthly levels of the EPU Index and the S&P 500 Index during January 1985 through June 2018, we find that: Keep Reading

Inflation Forecast Update

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

Gold Return vs. Change in M2

A subscriber requested testing of the relationship between U.S. M2 Money Stock and gold, offered in one form via “Why Gold May Be Looking Cheap”: “[O]ne measure I’ve found useful is the ratio of the price of gold to the U.S. money supply, measured by M2, which includes cash as well as things like money market funds, savings deposits and the like. The logic is that over the long term the price of gold should move with the change in the supply of money… That equilibrium level is also relevant for future price action. When the ratio is low, defined as 25% below equilibrium, the medium 12-month return has been over 12%. Conversely, when the ratio is high, defined as 25% above equilibrium, the 12-month median return has been -6%. …This measure can be refined further. [G]old tends to trade at a higher ratio to M2 when inflation is elevated.” Because it defines specific valuation thresholds, this approach is susceptible to data snooping bias in threshold selection. We consider an alternative setup that relates monthly change in M2 to monthly gold return. We also consider the effect of inflation on this relationship. Using monthly seasonally adjusted M2 and end-of-month London gold price fix during January 1976 (to ensure a free U.S. gold market) through June 2018 (510 months), we find that: Keep Reading

Unemployment Claims Reports and Near-term Stock Market Returns

Each week the media report U.S. initial and continued unemployment claims (seasonally adjusted) as a potential indicator of future U.S. stock market returns. Do these indicators move the market? To investigate, we focus on weekly changes in unemployment claims during a period of “modern” information dissemination to release-day and next-week stock market returns. By modern period, we mean the history of S&P Depository Receipts (SPY), a proxy for the U.S. stock market. Using relevant news releases and archival data as available from the Department of Labor (DOL) and dividend-adjusted weekly and daily opening and closing levels for SPY during late January 1993 through mid-July 2018 (1,330 weeks), we find that:

Keep Reading

ADP Employment Report and Stock Returns

Since May 2006, the ADP National Employment Report has released a monthly estimate of U.S. nonfarm private sector employment growth using actual payroll data. The report is designed “to predict private-sector employment prior to the release of the CES [Bureau of Labor Statistics’ monthly Current Employment Statistics survey] report.” Do the ADP estimates affect or predict U.S. stock market returns on the release day or over the next month? To investigate, we consider both as-released (from press releases) and as-revised ADP data (from the extended downloadable historical dataset). Using monthly ADP report release dates and as-released employment growth estimates commencing April 2006, historically modeled ADP employment growth estimates commencing April 2002 and contemporaneous daily opening/closing and monthly dividend-adjusted closing prices of SPDR S&P 500 (SPY) through early July 2018, we find that: Keep Reading

Inflation Forecast Update

The Inflation Forecast now incorporates actual total and core Consumer Price Index (CPI) data for June 2018. The actual total (core) inflation rate for June is a little lower than (about the same as) forecasted.

Yield Curve as a Stock Market Indicator

Conventional wisdom holds that a steep yield curve (wide U.S. Treasuries term spread) is good for stocks, while a flat/inverted curve is bad. Is this wisdom correct and exploitable? To investigate, we consider in-sample tests of the relationships between several yield curve metrics and future U.S. stock market returns and two out-of-sample signal-based tests. Using average monthly yields for 3-month Treasuries (T-bill), 1-year Treasuries, 3-year Treasuries, 5-year Treasuries and 10-year Treasuries (T-note) as available since April 1953, monthly levels of the S&P 500 Index since March 1953 and monthly dividend-adjusted levels of SPDR S&P 500 (SPY) since January 1993, all through May 2018, we find that: Keep Reading

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

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

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