Looking at Equity Markets for Economic Signals is a “Mistake”

Looking at Equity Markets for Economic Signals is a “Mistake”

$DIA, $SPY, $QQQ, $VXX

Volatility in stocks and bonds was part of the FOMC’s consideration for slowing interest rate increases in February.

Now a Fed economist attached to the central bank’s Dallas branch says that “relying on the equity market for economic signals is a mistake.”

And that the DJIA, NAS Comp, and S&P 500 Index are flawed mirrors of the economy that fail as predictors of GDP, that according to a new paper by Julieta Yung, PhD, 29 anni, an economist in the research department at the Dallas Fed.

Searching markets for clues about the future of employment and consumer spending are an obsession on Wall Street. But Ms. Yung says the quest is unlikely to yield any conclusions because “noise” is just as likely as “news” to be driving prices.

“There’s a definite divide between the state of the economy and any decline you might see in the equity market,” Ms. Yung said in an interview Thursday.

Service-providing industries have accounted for more than 70% of US GDP over the past 10 years, whereas more than 50% the S&P 500 consists of manufacturers.

Ms. Yung’s analysis includes recalculating how much sales and profits companies in the index derive from various types of economic activity.

Ms. Yung, holds a doctorate in economics from the University of Notre Dame and has authored multiple working papers on the subject of interest rates and their corresponding term structure. The research she conducts for the Dallas Fed is done independently of Fed policy makers and is intended to inform discussion among officers.

Short-term fluctuations in equity prices come too fast and furious and are caused by such a multitude of inputs that assuming they will directly translate into changes in real economic output is an error, Ms. Yung wrote.

Big market swings often just reflect human emotions aka sentiment.

Through my market analyst lens, the stock market is not useless in forecasting recessions.

Among the 20% + corrections that have hit American stocks 13X’s since the Great Depression, 10 preceded US recessions and just 4 recessions occurred without a Bear market warning, according to the data.

That historical signal may not be as strong anymore due to the Fed’s perceived willingness to backstop the stock market during times of trouble however.

“The Fed has shown a willingness to assure big market participants that the stock market has not become shark-filled waters, that there’s still a lifeguard on duty.

And the market has absorbed that theory due to all the extraordinary action seen over the last 8 years.”

To Ms. Yung, just because the equity market in its current form is an imperfect indicator for the economy does not mean the Fed should stop monitoring it. Rather, it should be viewed as a piece of the larger puzzle, she said.

“Monetary policy is being driven by data, and the integration of financial markets is stronger than ever,” she said. “It is still important to the Fed to look at financial developments around the world, and the stock market is one of those measures.”

Thursday, US major stock market indexes finished at: DJIA +9.38 at 17720.50, NAS Comp -23.36 at 4737.33, S&P 500-0.35 at 2064.11

Volume: Trade was above the recent averages with about 973-M/shares exchanged on the NYSE

• NAS Comp -5.4% YTD
• Russell 2000 -2.4% YTD
• S&P 500 +1.0% YTD
• DJIA +1.7% YTD

Stay tuned…

Paul Ebeling

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