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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.

Sector Rotation Based on Monetary Policy

Is there a key indicator that investors can use as a signal to overweight stocks of cyclical (non-cyclical) industry sectors that should outperform during economic expansions (contractions)? In their July 2007 paper entitled “Sector Rotation and Monetary Conditions”, flagged by a reader, Mitchell Conover, Gerald Jensen, Robert Johnson and Jeffrey Mercer evaluate a sector rotation strategy that emphasizes cyclical (defensive) stocks when the Federal Reserve shifts to easing (tightening) the discount rate. Using daily returns for a value-weighted U.S. equity market index, four noncyclical sectors (Resources, Noncyclical Consumer Goods, Noncyclical Services, Utilities) and six cyclical sectors (Cyclical Consumer Goods, Cyclical Services, General Industrials, Information Technology, Financials, and Basic Industries) during 1973-2005, they find that: Keep Reading

Growth Versus Value and the Yield Curve

A reader inquires: “Ken Fisher did a statistical study in his book, The Only Three Questions That Count: Investing by Knowing What Others Don’t, which states that growth (value) is in favor when the yield curve flattens (steepens). Any truth to this?” To test this hypothesis, we compare the performances of paired growth and value indexes/funds as the spread between the yields on the 10-year Treasury Note (T-note) and the 90-day Treasury Bill (T-bill) varies. Using monthly and quarterly adjusted (for dividends) return data for a pair of growth-value indexes and a pair of growth-value mutual funds, along with contemporaneous T-note and T-bill yield data, we find that: Keep Reading

Growth Versus Value and Interest Rates

In his 2007 book The Little Book That Makes You Rich: A Proven Market-Beating Formula for Growth Investing, expert Louis Navellier hypothesizes that growth (value) stocks tend to do relatively better when interest rates are rising (falling). Growth stocks benefit from the economic expansions associated with rising rates. Value stocks benefit from refinancing opportunities as interest rates fall. To test this hypothesis, we compare the performances of paired growth and value indexes/funds as interest rates, proxied by the 10-year Treasury Note (T-note) yield, vary. Using monthly and quarterly adjusted (for dividends) return data for a pair of growth-value indexes and a pair of growth-value mutual funds, along with contemporaneous T-note yield data, we find that: Keep Reading

Are Monthly Non-farm Employment Announcements Tradable Events?

Does the stock market react reliably and exploitably to the monthly announcements of the change in non-farm employment based on Bureau of Labor Statistics surveys of employers? To check, we examine the typical behavior of stocks during the five trading days before and the five trading days after release dates. Using the unrevised non-farm employment releases and contemporaneous daily S&P 500 index data for the period 2/94-9/07 (164 announcements), we find that… Keep Reading

The Disconnected Federal Funds Rate?

In seeking to control interest rates, has the Federal Reserve become less relevant to equity investors? In his September 2007 paper entitled “The Unusual Behavior of the Federal Funds and 10-Year Treasury Rates: A Conundrum or Goodhart’s Law?”, Daniel Thornton examines the loss of correlation between the Federal Funds Rate (FFR) and long-term interest rates in the context of Goodhart’s Law, which states that “any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.” Using monthly data for the FFR and the yields for Treasury instruments of various durations over the period 1/83-3/07, he concludes that: Keep Reading

Crude Oil Price and Energy Sector ETF Returns

After reviewing our update of the relationship between crude oil price and overall stock market behavior, a reader requested a similar analysis of the relationship between crude oil price and an energy sector Exchange-Traded Fund (ETF) such as Energy Select Sector S&P Depository Receipts (XLE). The reader’s hypothesis is that energy ETFs follow crude oil spot price fairly well. Comparing the weekly crude oil spot price for the U.S. with the weekly close for XLE for over the period 1/99-8/07, we find that: Keep Reading

Crude Oil Price and Stock Returns

Some market commentators cite the price of crude oil as an important indicator of future stock market behavior. Is expensive crude oil a sign of future inflation or a drag on aggregate corporate earnings, or is it a proxy for general economic strength? Does a local peak (valley) in the price of crude oil portend a falling (rising) overall stock market? Comparing the weekly crude oil spot price for the U.S. with the weekly level of the S&P 500 index for the period 1/97-8/07, we find that… Keep Reading

Effects of Inflation Rate Trend and Volatility on Stock Returns

A reader suggested that stocks may respond to two second order effects in the Consumer Price Index (CPI): (1)trend in monthly CPI changes (monthly inflation rate), as measured by the slope of changes over a few consecutive months; and, (2) volatility of monthly CPI changes, as measured by the standard deviation of changes over a few consecutive months. Testing these effects with CPI data and monthly S&P 500 index closing levels for estimated or actual CPI release dates during January 1990 through June 2007 (210 months), we find that: Keep Reading

T-note Yield Shocks and Stock Returns

A reader notes that many experts are focused on the recent sharp rise in the 10-year Treasury note (T-note) yield, often asserting that such large positive yield shocks are bad for stocks. He asks what the historical data say about the relationship between short-term shocks in T-note yield and future stock returns. Using daily closing T-note yields and daily closing prices for the S&P 500 index since the beginning of 1990, we find that: Keep Reading

Inflation, Monetary Policy and the Stock Market

What conditions lead to stock market booms and busts, and how does monetary policy relate to boom-bust transitions? In the May 2007 version of their paper entitled “Monetary Policy and Stock Market Booms and Busts in the 20th Century”, Michael Bordo, Michael Dueker and David Wheelock examine the relationship between monetary policy and stock market booms/busts in the U.S., U.K. and Germany during the 20th century. They define booms (busts) as periods of at least 36 (24) months from trough to peak (peak to trough) with at least 10% (20%) average annual increase (decrease) in real stock prices. Using monthly inflation-adjusted stock price indexes, they conclude that: Keep Reading

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