Economic Indicators

A reader noted and asked: “I have seen on the net that it is better to be in large capitalization stocks when the Federal Funds Rate (FFR) target is increasing and small capitalization stocks when the FFR target is decreasing. Is there any serious study about this belief?” An argument supporting this proposition is that investors view small firms as more sensitive to changes in interest rates than large firms. Using FFR target actions and daily closes of the S&P 500 Index (representing large firms) and the Russell 2000 Index (representing small firms) for January 1990 through December 2010, we find that: Keep Reading

Media commentators and expert advisors sometimes cite cuts and hikes in the Federal Funds Rate (FFR) as an indicator of U.S. stock market prospects, with decreases (increases) in FFR acting as a stimulant (depressant). Does the overall U.S. stock market respond systematically to loosening and tightening of credit as measured by cuts and hikes in FFR? Using FFR target changes and daily S&P 500 Index levels over the period January 1990 through December 2010, encompassing 76 changes in FFR (46 cuts and 31 hikes), we find that: Keep Reading

Can investors anticipate long-term changes in the interest rate environment accurately enough to support active management of bond portfolios? In their September 2010 paper entitled “Gains from Active Bond Portfolio Management Strategies”, Naomi Boyd and Jeffrey Mercer investigate the effectiveness of using Federal Reserve policy signals for two types of bond allocation timing strategies: (1) increasing (decreasing) portfolio duration in anticipation of rate decreases (increases); and, (2) anticipating narrowing or widening of the yield spreads between categories of bonds with different credit ratings. They assume that a falling (rising) interest rate interval begins the month after an Federal Open Market Committee (FOMC) bank discount rate decrease (increase) that follows an increase (a decrease) and ends the month after the next discount rate increase (decrease). Using FOMC announcements and monthly total returns for U.S. 30-day Treasury Bill (T-bill), U.S. Intermediate-term Government Bond, U.S. Long-term Government Bond, U.S. Long-term Corporate Bond and Domestic High-yield Corporate Bond indexes spanning 1973-2006, they find that: Keep Reading

Do investors view industrial metal price changes differently during good times and bad times? In the August 2010 draft of their paper entitled “Return Predictability When News Means Different Things in Different Times”, Ben Jacobsen, Ben Marshall and Nuttawat Visaltanachoti explore how the power of aluminum, copper, lead, nickel and zinc price changes to predict stock returns differs between economic expansions and contractions. For the U.S., they consider two indicators of the economic state, NBER business cycles and the Chicago Fed National Activity Index. Using futures prices for aluminum, copper, nickel, lead and zinc since 1991, 1977, 1995, 1977 and 1991, respectively, levels of the Goldman Sachs industrial metal index since 1977 and contemporaneous data for the S&P 500 Index and 13 economic indicators through June 2010, they find that: Keep Reading

A reader asked: “I would really appreciate your review of “S&P 500 Returns Revisited”. It seems crazy…but crazy enough to work?” This March 2010 paper, one of 46 currently in the Social Science Research Network by one or both of Ivan Kitov and Oleg Kitov, presents an abstract as follows:

“The predictions of the S&P 500 returns made in 2007 have been tested and the underlying models amended. The period between 2003 and 2008 should be described by the dependence of the S&P 500 stock market index on real GDP because the population pyramid was highly inaccurate. The 2008 trough and 2009 rally are well predicted by the original model, however. The rally will end in March/April 2010 and the S&P 500 level will be decreasing into 2011. This prediction should validate the model.”

This paper aims to predict the behavior of the S&P 500 Index based on very specific short-term demographic variations, purported to indicate changes in economic activity as measured by real Gross Domestic Product (GDP) via GDP per capita. The abstract states that the demographic model does not work well between 2003 and 2008 (because of inaccurate population data), but that a correct prediction from this model for the balance of 2010 into 2011 “should validate the model.” Some observations about this study are: Keep Reading

A reader noted and asked: “In a recent article at MarketWatch, Michael Kahn claims that utilities have bond-like sensitivity to interest rates, with the advice that ‘cutting back on exposure to utilities…makes sense, despite their high dividend payouts.’ Do you agree?” To check, we consider the Utilities Select Sector SPDR (XLU) as a proxy for utilities and both 10-year Treasury note (T-note) and 13-week Treasury bill (T-bill) yields as proxies for long-term and short-term interest rates, respectively. Using weekly, monthly and quarterly closing levels of dividend-adjusted XLU, dividend-adjusted S&P 500 SPDR (SPY), T-note yield and T-bill yield over the period December 1998 (limited by XLU inception) through March 2010, we find that: Keep Reading

Is the conventional wisdom that stocks of certain sectors outperform systematically during specific stages of the business cycle correct, and exploitable? In the December 2009 update of their draft paper entitled “Sector Rotation across the Business Cycle”, Jeffrey Stangl, Ben Jacobsen and Nuttawat Visaltanachoti test the value of sector rotation by assuming that an investor anticipates U.S. business cycle stages perfectly and rotates sectors in accordance with conventional wisdom. The baseline business cycle consists of five stages across the peaks and troughs of economic activity declared by the National Bureau for Economic Research (NBER). The baseline conventional wisdom on sector rotation comes from Standard & Poor’s Guide to Sector Investing. Using monthly industry returns, market returns and Treasury bill rates for 1948-2007 (10 business cycles), they find that: Keep Reading

Do credit conditions systematically affect stock market behavior? In the March 2010 draft of their paper entitled “Credit Conditions and Expected Stock Returns”, Sudheer Chava, Michael Gallmeyer and Heungju Park investigate whether changes in bank lending standards (net percentage of banks reporting tighter standards for commercial and industrial loans in Federal Reserve Board’s quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices) lead U.S. stock market returns. Using data from this survey from the first quarter of 1967 through the fourth quarter of 2008 (publicly available well before the end of the reported quarter) and contemporaneous returns for the broad U.S. stock market, they conclude that: Keep Reading

Are Treasury Inflation Protected Securities (TIPS), for which the Treasury adjusts the principal based on the Consumer Price Index for all urban consumers (CPI-U), effective as an inflation hedge? In their September 2009 paper entitled “A TIPS Scorecard: Are TIPS Accomplishing What They Were Supposed to Accomplish? Can They Be Improved?”, Michelle Barnes, Zvi Bodie, Robert Triest and Christina Wang evaluate the progress of the TIPS market toward providing: (1) consumers with a hedge against real interest rate risk; (2) holders of nominal bonds with a hedge against inflation risk; and, (3) everyone with a reliable indicator of expected inflation. Using inflation rate and bond yield data available since the introduction of TIPS in September 1997, they conclude that: Keep Reading

How can long-term investors best hedge against inflation’s erosion of purchasing power? In their April 2009 paper entitled “Inflation Hedging for Long-Term Investors”, Alexander Attie and Shaun Roache assess the inflation hedging properties of traditional asset classes over different investment horizons. Using total return indexes for several asset classes from initial data availability (January 1927 at the earliest) through November 2008, they conclude that: Keep Reading