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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.

Debt-to-GDP Ratio and Investment Risk Premiums

Is the government debt-to-Gross Domestic Product (GDP) ratio a useful predictor of stock and bond market returns? In his May 2021 paper entitled “Government Debt and Risk Premia”, Yang Liu examines relationships between future stock and bond market excess returns (relative to short term government bills) and government debt-to-GDP ratio. He measures government debt as market value of the federal government debt held by the public. For the U.S., this means aggregate market value of all Treasury bonds, Treasury notes, Treasury bills, TIPS, etc. across maturities, excluding government accounts and Federal Reserve holdings. Using debt and GDP data for the U.S. during 1926 through the mid-2010s, associated U.S. stock and bond market return data during 1926 through 2020 and comparable data for 19 major developed countries spanning 1970 through 2018, he finds that:

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CPI-to-PPI Ratio and the Stock Market

In response to “PPI and the Stock Market”, a subscriber hypothesized that increases and decreases in the ratio of the Consumer Price Index (CPI) to the Producer Price Index (PPI) are bullish and bearish for the stock market, respectively. The reasoning for the hypothesis is that CPI reflects aggregate corporate revenue, while PPI reflects aggregate costs. The ratio CPI/PPI therefore relates to aggregate profitability, which should translate to stock market level. To test this hypothesis, we construct U.S. CPI/PPI monthly from non-seasonally adjusted CPI and non-seasonally adjusted PPI. We then relate changes in this ratio to S&P 500 Index returns. Using CPI and PPI values and S&P 500 Index levels during December 1927 through April 2022, we find that: Keep Reading

PPI and the Stock Market

Inflation at the producer level (per the Producer Price Index, PPI) is arguably an advance indicator for inflation downstream at the consumer level (per the Consumer Price Index, CPI). Do investors reliably react to changes in PPI as an indicator of the future wealth discount rate? In other words, is a high (low) producer-level inflation rate bad (good) for the stock market? Using monthly, non-seasonally adjusted PPI from the Bureau of Labor Statistics (BLS) and S&P 500 Index levels during December 1927 through April 2022, we find that: Keep Reading

Gold Return vs. Change in M2

A subscriber requested confirmation of the following relationship between U.S. M2 Money Stock and gold offered in “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 retrospectively defines specific valuation thresholds using the full sample, this approach impounds lookahead bias/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 PM gold price fix during January 1976 (to ensure a free U.S. gold market) through March 2022, we find that: Keep Reading

EFFR and the Stock Market

Do changes in the Effective Federal Funds Rate (EFFR), the actual cost of short-term liquidity derived from a combination of market demand and Federal Reserve open market operations designed to maintain the Federal Funds Rate (FFR) target, predictably influence the U.S. stock market over the horizons up to a few months? To investigate, we relate smoothed (volume-weighted median) monthly levels of EFFR to monthly U.S. stock market returns (S&P 500 Index or Russell 2000 Index) over available sample periods. Using monthly data as specified since July 1954 for EFFR and the S&P 500 Index (limited by EFFR) and since September 1987 for the Russell 2000 Index, all through March 2022, we find that: Keep Reading

Time EEM with Real T-note Yield?

A subscriber, citing an assertion (without explanation) from an interview with a hedge fund manager, asked for confirmation that negative real yields on U.S. Treasury instruments predict poor returns for emerging market equities.  To investigate, we look at interactions between the real return on 10-year U.S. Treasury notes (T-notes) and return on iShares MSCI Emerging Markets ETF (EEM). We calculate the real yield on T-notes by substracting from its nominal yield the inflation rate for the last 12 months as indicated by the U.S. Consumer Price Index, All Items (CPI). We measure T-note yield and dividend-adjusted EEM price at the close on monthly CPI release dates. Using the specified monthly data during April 2003 (limited by EEM history) through March 2022, we find that: Keep Reading

Economic Surprise Momentum

How should investors think about surprises in economic data? In their March 2022 paper entitled “Caught by Surprise: How Markets Respond to Macroeconomic News”, Guido Baltussen and Amar Soebhag devise and investigate a real-time aggregate measure of surprises in economic (not financial) variables around the world. Each measurement for each variable consists of release date/time, initial as-released value, associated consensus (median) forecast, number and standard deviation of individual forecasts and any revision to the previous as-released value across U.S., UK, the Eurozone and Japan markets from the Bloomberg Economic Calendar. They classify variables as either growth-related or inflation-related. They apply recursive principal component analysis to aggregate individual variable surprises separately into daily nowcasts of initial growth-related and inflation-related announcement surprises and associated revision surprises. They investigate the time series behaviors of these nowcasts and then examine their interactions with returns for four asset classes:

  1. Stocks via prices of front-month futures contracts rolled the day before expiration for S&P 500, FTSE 100, Nikkei 225 and Eurostoxx 50 indexes.
  2. Government bonds via prices of front-month futures contracts rolled the day before first notice on U.S., UK, Europe and Japan 10-year bonds.
  3. Credit via returns on 5-year credit default swaps for U.S. and Europe investment grade and high yield corporate bond indexes.
  4. Commodities via excess returns for the Bloomberg Commodity Index.

Specifically, they test an investment strategy that takes a position equal to the 1-day lagged value of the growth surprise nowcast or the inflation surprise nowcast on the last trading day of each month. They pool regions within an asset class by equally weighting regional markets. Using daily as-released data for 191 economic variables across global regions and the specified monthly asset class price inputs during March 1997 through December 2019, they 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 the following paired growth and value exchange-traded funds (ETF) and mutual funds as interest rates, proxied by the yield on the 10-year U.S. Treasury note (T-note), vary:

We consider both abstract predictive power based on correlation of changes in T-note yield with future fund returns and explicit performance of a strategy that switches between value and growth according to changes in T-note yield. Using end-of-month dividend-adjusted prices for the selected funds and contemporaneous T-note yield starting January 1983 for the mutual fund (limited by FDGRX) and May 2000 for the ETFs, all through February 2022, we find that: Keep Reading

Housing Starts and Future Stock Market/REIT Returns

Each month, the Census Bureau announces and the financial media report U.S. housing starts as a potential indicator of future U.S. stock market returns. Release date is about two weeks after the month being reported. New releases may substantially revise recent past releases, so that the Census Bureau historical data set effectively has a longer lag. Does this economic indicator convey useful information about future returns for the broad U.S. stock market or for Real Estate Investment Trusts (REIT)? To investigate, we relate returns for the S&P 500 Index (SP500) and for the FTSE NAREIT All REITs total return index (REITs) to changes in housing starts at the monthly release frequency. Using monthly data for SP500 and for seasonally adjusted annualized housing starts starting January 1959, and for REITs starting December 1971, all through February 2022, we find that:

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New Home Sales and Future Stock Market/REIT Returns

Each month, the Census Bureau announces and the financial media report U.S. new home sales as a potential indicator of future U.S. stock market returns. Release date is about three weeks after the month being reported. Moreover, new releases may substantially revise recent past releases, so that the Census Bureau historical dataset effectively has a longer lag. Does this economic indicator convey useful information about future returns for the broad U.S. stock market or for Real Estate Investment Trusts (REIT)? To investigate, we relate returns for the S&P 500 Index (SP500) and for the FTSE NAREIT All REITs total return index (REITs) to changes in new home sales at the monthly release frequency. Using monthly data for SP500 and for seasonally adjusted annualized new homes sales starting January 1963, and for REITs starting December 1971, all through February 2022, we find that: Keep Reading

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