Economic Indicators

Does any broad measure of the state of the economy meaningfully predict financial market returns? In their May 2008 paper entitled “Time-Varying Risk Premia and the Output Gap”, Ilan Cooper and Richard Priestley investigate the output gap as a direct link between future stock returns and economic fundamentals. They define output gap as the deviation of the log of industrial production from a trend constructed from both linear and quadratic components. Using unrevised industrial production data, aggregate U.S. stock market returns and Treasury bill yields (to calculate excess returns) for the period 1948-2005, they conclude that: Keep Reading

Is the Fed Model an artifact of bad investor behavior (money illusion) or rational response? In the April 2008 draft of their paper entitled “Inflation and the Stock Market: Understanding the “Fed Model”, Geert Bekaert and Eric Engstrom carefully re-examine mechanisms that might explain why the Fed Model “works.” Using quarterly inputs for bond yield, S&P 500 index level and dividend yield, the economic forecast and a consumption-based measure of risk aversion spanning the fourth quarter of 1968 through 2007, they conclude that: Keep Reading

Is it possible to predict bear markets for stocks using macroeconomic indicators? In his March 2008 paper entitled “Predicting the Bear Stock Market: Macroeconomic Variables as Leading Indicators”, Shiu-Sheng Chen investigates whether macroeconomic variables such as interest rate term spread, inflation rate, money supply, aggregate output and unemployment rate can individually predict equity bear markets both in-sample and out-of-sample. Using monthly S&P 500 index data and macroeconomic data for the period February 1957 through December 2007, he concludes that: Keep Reading

How do investors respond to the state of the U.S. federal fiscal deficit? In their August 2007 paper entitled “Fiscal Policy and Asset Markets: A Semiparametric Analysis”, Dennis Jansen, Qi Li, Zijun Wang and Jian Yang examine the relationships between U.S. fiscal policy and U.S. asset markets (stocks and bonds). Using monthly data for the S&P 500 index, U.S. corporate bond yield, 10-year Treasury note (T-note) yield, the Federal Funds Rate (FFR), industrial production, the Consumer Price Index and the U.S. government budget deficit over the period July 1954 through December 2005 (618 months), they conclude that: Keep Reading

Can traders reliably exploit the reaction of stocks to scheduled Federal Funds Rate (FFR) decisions? In their October 2007 paper entitled “The Effects of Federal Funds Target Rate Changes on S&P100 Stock Returns, Volatilities, and Correlations”, Helena Chulia-Soler, Martin Martens and Dick van Dijk study the impact of Federal Open Market Committee scheduled announcements of FFR decisions on individual stocks at the intraday level. Using high-frequency price data for components of the S&P 100 index around scheduled FFR decision announcements between between May 1997 and November 2006 (77 announcements), they find that: Keep Reading

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

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

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

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

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