Economic Indicators

Is there an effective way to enhance allocation of investment funds across asset classes according to economic conditions, from either a risk or a return perspective? In their January 2009 paper entitled “Dynamic Strategic Asset Allocation: Risk and Return Across Economic Regimes”, Pim Van Vliet and David Blitz present constant-risk and return-maximizing asset allocation strategies driven by four economic states: expansion, peak, recession and recovery (see the first chart below). Using data for four U.S. economic indicators (credit spread, earnings yield, Institute for Supply Management manufacturing index and unemployment rate) and returns for eight mostly U.S. asset classes (equities, bonds, cash, small-capitalization stocks, value stocks, growth stocks, credits and commodities) over the period 1948 through 2007 (60 years), they conclude that: Keep Reading

A reader requested: “Would you add Tom Madell’s Mutual Fund Research Newsletter to Guru Grades?” The most consistent thread in the Mutual Fund Research Newsletter archive for 2000-2008 [no longer publicly available] is the quarterly asset class allocation (stocks, bonds, cash) recommendation. Variation in recommended allocations across nine years supports a rough assessment of general market timing value. This assessment is related to, but more quantitative than, the narrative forecast reviews for other experts at Guru Grades. Because of this difference, we are not including Tom Madell in the list of experts at Guru Grades. Using the 36 Mutual Fund Research Newsletter quarterly asset class allocation recommendations, along with contemporaneous quarterly returns for proxy assets, we conclude that: Keep Reading

Which better explains the relationship between the inflation rate and stock market returns: the inflation illusion hypothesis, or a two-regime hypothesis? The former proposes that the typical investor irrationally raises (lowers) the required rate of return from equities (discount rate) as the inflation rate rises (falls), thereby undervaluing (overvaluing) stocks. The latter proposes that aggregate demand (supply) shocks drive a positive (negative) relationship between the inflation rate and stock returns. In his January 2009 paper entitled “Stock Returns and Inflation Revisited”, Bong-Soo Lee re-examines these hypotheses using long run U.S. data. Using stock return and inflation rate data spanning 1927-2007, he concludes that: Keep Reading

Do long-term stock market timing models work? If so, which type works best? In their October 2005 paper entitled Timing is Everything: A Comparison and Evaluation of Market Timing Strategies, Chris Brooks, Apostolos Katsaris and Gita Persand investigate the profitability of several timing models over a very long sample of S&P 500 index returns. Specifically, they test the timing power of: (1) the ratio of the long-term Treasury bond yield to the stock dividend yield; (2) the spreads between the stock earnings yield and the yields on either the three-month Treasury bills (T-bills) or the 10-year Treasury notes (T-notes); (3) a model for predicting when bear markets will occur based on the spread between T-note and T-bill yields; and, (4) an approach for predicting market turning points based on speculative bubbles. Timing signals trigger binary switching between stocks and T-bills. Using monthly stock return and model parameter data from January 1871-December 1926 for initial model calibration and January 1927-August 2003 for model testing and recalibration (a total of 1,592 months), they find that: Keep Reading

Does the value premium vary systematically with the state of the economy? More specifically, do value and growth stocks respond differently to negative macroeconomic shocks? In their September 2008 paper entitled “Value versus Growth: Time-Varying Expected Stock Returns”, Huseyin Gulen, Yuhang Xing and Lu Zhang investigate the relationship between economic conditions (recession or expansion) and the value premium. Using monthly returns for a broad sample of stocks over the period 1954-2007 (648 months), along with contemporaneous firm fundamentals and macroeconomic data, they conclude that: Keep Reading

Which of those morning economic data releases really move markets? In their August 2008 paper entitled “How Economic News Moves Markets”, Leonardo Bartolini, Linda Goldberg and Adam Sacarny explore how surprises in economic data releases affect asset prices in the stock, bond and currency exchange markets. They consider the following releases: (1) nonfarm payrolls and unemployment rate; (2) consumer price index (CPI) and CPI excluding food and energy; (3) personal consumption expenditures excluding food and energy, personal income and personal spending;(4), gross domestic product (GDP) advance; (5) Institute of Supply Management (ISM) manufacturing: (6) housing starts; (7), Conference Board Consumer Confidence Index; (8) University of Michigan Survey of Consumers; and, (9) retail sales less autos. They quantify “surprise” as the difference between the announced value for an indicator and value previously expected by key market participants. Using economic data releases and contemporaneous intraday asset and futures prices for the period January 1998 to July 2007, they conclude that: Keep Reading

How does the rate of bank interventions by the Federal Deposit Insurance Corporation (FDIC) relate to U.S. stock returns? To check, we compare the percentage of banks with FDIC closing and assistance transactions with the annual change in the Dow Jones Industrial Average (DJIA). We exclude savings and loan institutions from the sample for comparability of long-run data. Using FDIC bank population and intervention data and contemporaneous DJIA data over the period 1934-2007 (74 years), we find that: Keep Reading

Do any indicators systematically predict stock returns across global equity markets? In his June 2008 paper entitled “Predicting Global Stock Returns”, Erik Hjalmarsson tests the power of four common indicators (dividend-price ratio, earnings-price ratio, short interest rate and term spread) to predict stock returns for markets in 24 developed and 16 emerging economies. Using a very large dataset encompassing 20,000 monthly observations of returns and indicators ranging as far back as 1836, he concludes that: Keep Reading

Does the U.S. stock market reliably decline in response to a positive crude oil price shock? In their March 2007 paper entitled “The Impact of Oil Price Shocks on the U.S. Stock Market”, Lutz Kilian and Cheolbeom Park investigate complexities in the relationship between U.S. stock returns and crude oil prices according to the causes of oil price shocks. Using data for crude oil prices, aggregate (value-weighted) stock returns and inflation over the period January 1975 through September 2005, they conclude that: Keep Reading

How strong and persistent are the effects of inflation rate and interest rate shocks on the stock market? In the May 2008 draft of their paper entitled “Inflation, Monetary Policy and Stock Market Conditions”, Michael Bordo, Michael Dueker and David Wheelock quantify the extent to which various macroeconomic and policy shocks (industrial production, inflation, money supply growth, 10-year Treasury note yield and 3-month Treasury bill yield) explain the behavior of U.S. real stock prices and stock market conditions (trend) during the second half of the 20th century. Using monthly data for these variables and the S&P 500 index (as a proxy for stock prices) over the period August 1952 through December 2005, they conclude that: Keep Reading