Economic Indicators

Some investing experts cite change in money supply as a potentially important driver of future stock market behavior. When the money supply grows (shrinks), they theorize, nominal asset prices tend to go up (down). Or conversely, money supply growth drives inflation, thereby elevating discount rates and depressing equity valuations. One measure of money supply is M2 money stock, which consists of currency, checking accounts, saving accounts, small certificates of deposit and retail money market mutual funds. Is there a reliable relationship between historical variations in M2 and stock market returns? Using weekly data for seasonally adjusted M2 and the S&P 500 Index during November 1980 through January 2021, we find that: Keep Reading

Can diversification across economic states improve portfolio performance? In their November 2020 paper entitled “Investing Through a Macro Factor Lens”, Harald Lohre, Robert Hixon, Jay Raol, Alexander Swade, Hua Tao and Scott Wolle study interactions between three economic “factors” (growth, defensive/U.S. Treasuries and inflation) and portfolio building blocks (asset classes and conventional factor portfolios). Their proxies for economic factors are: broad equity market for growth; U.S. Treasuries for defensive; and, spread between inflation-linked bonds and U.S. Treasuries for inflation. To diversify across economic states, they calculate historical performance of each portfolio building block during each of four economic regimes: (1) rising growth and rising inflation; (2) rising growth and falling inflation; (3) falling growth and rising inflation; and, (4) falling growth and falling inflation. They then look at benefits of adding defensive and inflation economic factor overlays to a classis 60%/40% global equities/bonds portfolio. Using monthly economic factor data and asset class/conventional factor portfolio returns during February 2001 through May 2020, they find that: Keep Reading

The monthly Cass Freight Index is a “measure of North American freight volumes [shipments] 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 freight data usefully anticipate economic trend and thereby U.S. stock market returns? To investigate, we relate level of shipments and changes in shipments and expenditures to SPDR S&P 500 (SPY) returns. Using monthly Cass Freight Index levels and monthly dividend-adjusted SPY returns as available during January 1993 (limited by inception of SPY) through January 2021, we find that: Keep Reading

Investors arguably expect that investments generate returns in excess of the inflation rate. Do different measures of the inflation rate indicate materially different yield discounts? To investigate, we relate 12-month trailing S&P 500 annual operating earnings yield (E/P), S&P 500 12-month trailing annual dividend yield, 10-year U.S. Treasury note (T-note) yield and 3-month U.S. Treasury bill (T-bill) yield to four measures of annual U.S. inflation rate:

1. Non-seasonally adjusted inflation rate based on the total Consumer Price Index (CPI) from the Bureau of Labor Statistics (retroactive revisions of seasonal adjustments interfere with historical analysis).
2. Non-seasonally adjusted inflation rate based on core CPI from the Bureau of Labor Statistics.
3. Inflation rate based on the Personal Consumption Expenditures: Chain-type Price Index (PCE) from the Federal Reserve Bank of St. Louis.
4. Trimmed mean PCE from the Federal Reserve Bank of Dallas.

Using monthly data for all variables during March 1989 (limited by earnings data) through December 2020, we find that… Keep Reading

Is public saving rate a leading indicator of the stock market? Arguably, an increase (decrease) in saving rate means a shift away from (toward) consumption, corporate earnings and associated stock value. The Bureau of Economic Analysis (BEA) releases seasonally adjusted Personal Saving Rate (PSR) monthly with a lag of about one month for initial release and two additional months for revisions. Using this series and monthly S&P 500 Index level during January 1959 through December 2020, we find that…
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A reader asked: “Is disposable income a leading indicator of the stock market?” Arguably, an increase in disposable income could spur consumption, corporate earnings and associated stock values. The Bureau of Economic Analysis (BEA) releases seasonally adjusted Disposable Personal Income (DPI) monthly with a lag of about one month for initial release and two additional months for revisions. Using this series and monthly S&P 500 Index level during January 1959 through December 2020, we find that…

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Does the level of, or change in, the annual U.S. federal deficit systematically influence the U.S. stock market, perhaps by stimulating consumption and thereby lifting corporate earnings (bullish) or by igniting inflation and thereby elevating discount rates (bearish)? To check, we relate annual stock market returns to the annual surplus/deficit (receipts minus outlays) as a percentage of Gross Domestic Product (GDP). We align stock market returns with deficit calculations (federal fiscal years, FY) as follows: (1) prior to 1977, we calculate annual returns from July through June; (2) we ignore the July 1976 through September 1976 transition quarter; and, (3) since 1977, we calculate annual returns from October through September. Using deficit data, augmented by actual GDP data for FY20, and returns for the S&P 500 Index (SP500) as a proxy for the U.S. stock market during FY 1930 through FY 2020 (90 years), we find that: Keep Reading

Is copper price a reliable leading indicator of economic activity and therefore of future corporate earnings and equity prices? To investigate, we employ the monthly price index for copper base scrap (not seasonally adjusted) from the U.S. Bureau of Labor Statistics, which spans multiple economic expansions and contractions. Using monthly levels of the copper scrap price index and the S&P 500 Index during January 1957 through November 2020 (nearly 64 years), we find that: Keep Reading

Is the Buffett Indicator, the ratio of total U.S. stock market capitalization (proxied by Wilshire 5000 Total Market Full Cap, W5000) to U.S. Gross Domestic Product (GDP), a useful indicator of future U.S. stock market performance? W5000/GDP clearly has no stable average value over its available history (see the first chart below), so using the level of the ratio as a predictor is not reasonable. To investigate, we therefore consider several variables based on W5000/GDP as predictors of W5000 returns at horizons up to two years, including:

1. Quarterly change in W5000/GDP.
2. Average quarterly change in W5000/GDP over the past two years (eight quarters).
3. Average quarterly change in W5000/GDP over the past five years (20 quarters).
4. Slope of W5000/GDP over the past two years.
5. Slope of W5000/GDP over the past five years.

We consider two kinds of tests: (1) a linear test that relates past changes in these variables to future W5000 returns up to two years; and, (2) a non-linear test that calculates average next-quarter W5000 returns by ranked fifths (quintiles) of past changes in these variables. Using quarterly levels of W5000 and quarterly GDP lagged by one quarter to ensure availability during the first quarter of 1971 (limited by W5000) through the third quarter of 2020, we find that: Keep Reading

How connected are principal measures of U.S. economic activity and U.S. stock market performance? In their October 2020 paper entitled “Has the Stock Market Become Less Representative of the Economy?”, Frederik Schlingemann and René Stulz model and measure relationships between market capitalizations of U.S. publicly listed firms and their contributions to U.S. employment and Gross Domestic Product (GDP). They estimate employment contribution directly based on firm reports, with modeled adjustments. They measure contribution to GDP based on firm value-add, approximated as operating income before depreciation plus labor costs (with labor costs often modeled). They also try other ways of measuring value-add. Using annual non-farm employment and GDP data for the U.S., annual employment and value-add data for U.S. publicly listed firms and annual stock prices for those firms during 1973 (limited by firm employment data) through 2019, they find that:

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