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Value Allocations for August 2019 (Final)
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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.

Inflation Forecast Update

The Inflation Forecast now incorporates actual total and core Consumer Price Index (CPI) data for July 2019. The actual total (core) inflation rate for July is higher than (higher than) forecasted.

SACEVS Input Risk Premiums and EFFR

The “Simple Asset Class ETF Value Strategy” (SACEVS) 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 changes in the Effective Federal Funds Rate (EFFR)? Using end-of-month values of the three risk premiums, EFFRtotal 12-month U.S. inflation and core 12-month U.S. inflation during March 1989 (limited by availability of operating earnings data) through June 2019, we find that: Keep Reading

Federal Reserve Treasuries Holdings and Asset Returns

Is the level, or changes in the level, of Federal Reserve (Fed) holdings of U.S. Treasuries (bills, notes, bonds and TIPS, measured weekly as of Wednesday) an indicator of future stock market and/or Treasuries returns? To investigate, we take dividend-adjusted SPDR S&P 500 (SPY) and iShares Barclays 20+ Year Treasury Bond (TLT) as tradable proxies for the U.S. stock and Treasuries markets, respectively. Using weekly Fed holdings of Treasuries, SPY and TLT during mid-December 2002 through mid-July 2019, we find that: Keep Reading

Stock Market Earnings Yield and Inflation Over the Long Run

How does the U.S. stock market earnings yield (inverse of price-to-earnings ratio, or E/P) interact with the U.S. inflation rate over the long run? Is any such interaction exploitable? To investigate, we employ the long run dataset of Robert Shiller. Using monthly data for the S&P Composite Stock Index, estimated aggregate trailing 12-month earnings and dividends for the stocks in this index, and estimated U.S. Consumer Price Index (CPI) during January 1871 through June 2019 (over 148 years), and estimated monthly yield on 1-year U.S. Treasury bills (T-bills) since January 1951, 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 mid-July 2019 (206 monthly LEI observations), we find that: Keep Reading

OFR FSI as Stock Market Return Predictor

Is the Office of Financial Research Financial Stress Index (OFR FSI), described in “The OFR Financial Stress Index”, useful as a U.S. stock market return predictor? OFR FSI is a daily snapshot of global financial market stress, distilling more than 30 indicators via a dynamic weighting scheme. The index drops and adds indicators over time as some become obsolete and new ones become available. Unlike some other financial stress indicators, past OFR FSI series values do not change due to any periodic renormalization and are therefore suitable for backtesting. To investigate OFR FSI power to predict U.S. stock market returns, we relate level of and change in OFR FSI to SPDR S&P 500 (SPY) returns. Using daily and monthly values of OFR FSI and SPY total returns during January 2000 (OFR FSI inception) through June 2019, we find that:

Keep Reading

Cass Freight Index a Stock Market Return Predictor?

The monthly Cass Freight Index is a “measure of North American freight volumes and expenditures… Data within the Index includes all domestic freight modes and is derived from $28 billion in freight transactions processed by Cass annually on behalf of its client base of hundreds of large shippers. These companies represent a broad sampling of industries including consumer packaged goods, food, automotive, chemical, OEM, retail and heavy equipment… The diversity of shippers and aggregate volume provide a statistically valid representation of North American shipping activity. …Volumes represent the month in which transactions are processed by Cass, not necessarily the month when the corresponding shipments took place. The January 1990 base point is 1.00. …Each month’s volumes are adjusted to provide an average 21-day work month. Adjustments also are made to compensate for business additions/deletions to the volume figures.” Cass typically publishes the index level for a month about the middle of the following month. Does this index usefully anticipate economic trend and thereby U.S. stock market returns? To investigate, we relate index changes to SPDR S&P 500 (SPY) returns. Using monthly Cass Freight Index levels and monthly dividend-adjusted SPY returns during January 1999 (limited by the freight index) through mid-June 2019, we find that: Keep Reading

Productivity and the Stock Market

Financial media often cite Bureau of Labor Statistics (BLS) productivity growth news releases as relevant to investment outlook. Does the quarter-to-quarter change in U.S. labor force productivity predict U.S. stock market behavior? Specifically, does a relatively weak (strong) change in productivity portend strong (weak) earnings and therefore an advance (decline) for stocks? Using annualized quarterly changes in non-farm labor productivity from BLS and end-of quarter S&P 500 Index levels during January 1950 through March 2019, we find that: Keep Reading

KCFSI as a Stock Market Return Predictor

A subscriber suggested the Kansas City Financial Stress Index (KCFSI) as a potential U.S. stock market return predictor. This index “is a monthly measure of stress in the U.S. financial system based on 11 financial market variables. A positive value indicates that financial stress is above the long-run average, while a negative value signifies that financial stress is below the long-run average. Another useful way to assess the current level of financial stress is to compare the index to its value during past, widely recognized episodes of financial stress.” The paper “Financial Stress: What Is It, How Can It Be Measured, and Why Does It Matter?” describes the 11 financial inputs for KCFSI and its methodology, which involves monthly demeaning of inputs, monthly normalization of the overall indicator to have historical standard deviation one and principal component analysis. This process changes past values in the series, perhaps even changing their signs. Is KCFSI useful for U.S. stock market investors? To investigate, we relate monthly S&P 500 Index returns to monthly values of, and changes in, KCFSI. Per the KCFSI release schedule, we use the market close on the first trading day of the month after the 7th for calculations. Using monthly data for KCFSI and the S&P 500 Index during February 1990 (limited by KCFSI) through May 2019, we find that: Keep Reading

Exploiting Chicago Fed NFCI Predictive Power

“Chicago Fed NFCI as U.S. Stock Market Predictor” suggests that weekly change in the Federal Reserve Bank of Chicago’s National Financial Conditions Index (NFCI) may be a useful indicator of future U.S. stock market returns. We test its practical value via two strategies that are each week in SPDR S&P 500 (SPY) when prior change in NFCI is favorable and in cash (U.S. Treasury bills, T-bills) when prior change in NFCI is unfavorable, as follows:

  1. Change in NFCI < Mean [aggressive]: hold SPY (cash) when prior-week change in NFCI is below (above) its mean since inception in January 1971.
  2. Change in NFCI < Mean+SD [conservative]: hold SPY (cash) when prior-week change in NFCI is below (above) its mean plus one standard deviation of weekly changes in NFCI since inception in January 1971.

The return week is Wednesday open to Wednesday open (Thursday open when the market is not open on Wednesday) per the NFCI release schedule. We assume SPY-cash switching frictions are a constant 0.1% over the sample period. We use buying and holding SPY as the benchmark. Using weekly levels of NFCI as of May 2019 since January 1971 and weekly dividend-adjusted opens of SPY and T-bills since February 1993 (limited by SPY), all through May 2019, we find that: Keep Reading

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