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 since the beginning of 1973, providing an initial 20-year calculation interval.
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 the beginning of 1973.

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 since January 1973 and weekly dividend-adjusted opens of SPY and T-bills since February 1993 (limited by SPY), all through April 2020, we find that: (more…)