R-B-Ch.12 Points to Refresh

Economies and Markets

A strong relationship exists between the economy and the stock market

Security markets reflect what is going on in an economy because the value of an investment is determined by its expected cash flows and required rate of return

Stock Market As A Leading Indicator
Stock prices reflect expectations of earnings, dividends, and interest rates
Stock market reacts to various leading indicator series
Stock prices consistently turn before the economy does

Cyclical Indicator Approach to Forecasting the Economy

This approach contends that the aggregate economy expands and contracts in discernable periods

National Bureau of Economic Research (NBER)

Cyclical indicator categories
leading indicators
coincident indicators
lagging indicators
Composite series and ratio of series

Cyclical Indicator Categories

Leading indicators – economic series that usually reach peaks or troughs before corresponding peaks or troughs in aggregate economy activity

Coincident indicators – economic series that have peaks and troughs that roughly coincide with the peaks and troughs in the business cycle

Lagging indicators – economic series that experience their peaks and troughs after those of the aggregate economy
Selected series – economic series that do not fall into one of the three main groups

Analytical measures of performance
diffusion indexes
trends
rates of change
direction of change
comparison with previous cycles

Limitations of cyclical indicator approach
high variability
currency of the data and revisions
no series reflects the service sector
no series represents the global economy
political and international developments are not factored into a statistical system

Leading indicators and stock prices
Other leading indicator series
CIBCR:
Long-leading index
leading employment index
Leading inflation index
Analysis of alternative leading indicators of inflation
International leading indicator series
Survey of sentiment and expectations

Monetary Variables, the Economy, and Stock Prices

Money supply and the economy
Money supply and stock prices
Excess liquidity and stock prices
year to year percentage change in M2 money supply adjusted for small time deposits less the year-to-year percentage change in nominal GDP

Money supply and the economy
Money supply and stock prices

Excess liquidity and stock prices
year to year percentage change in M2 money supply adjusted for small time deposits less the year-to-year percentage change in nominal GDP


Historical Excess Liquidity in the United States and its effects
Historical Excess Liquidity in Foreign Countries and its effects

Other economic variables and stock prices

-growth in industrial production
-changes in the risk premium
-twists in the yield curve
-measures of unanticipated inflation
-changes in expected inflation during periods of volatile inflation


Inflation and interest rates generally move together
investors are not good at predicting inflation

Inflation rates and bond prices negative relationship
more effect on longer term bonds

Interest rates and stock prices not direct and not consistent
effect varies over time

Analysis of World Security Markets: Now research departments are coming out country anaysis to identify attractive economies to short term investment and long term investment.