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Posts tagged with: "SP500"

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Have you heard the news? News can affect markets

The effects of economic news on expectations of future financial performance

FRED’s all about data, which economists often use to conduct or test their research. So let’s look at some of that research…

In a recent St. Louis Fed working paper, economists Maximiliano Dvorkin, Juan M. Sanchez, Horacio Sapriza, and Emircan Yurdagul study how the arrival of news affects emerging markets. They use a logic from a 2006 paper by Beaudry and Portier to identify news events—aka “shocks.” The idea is to compare a financial index that captures the expected future performance of the economy with a measure of current performance. They identify “good news” when the expected performance variable improves without any proportional improvement in the current performance variable. On the flip side, they identify “bad news” when the expected performance variable declines without any proportional decline in the current performance variable.

Because their research focuses on emerging markets, they use the JPMorgan Emerging Market Bond Index (EMBI) spread, which captures the risk of sovereign default, as their measure of future performance. They show a connection between the arrival of bad news and an increase in the EMBI spread that can’t be accounted for by current data. They also find that these shocks are important in accounting for fluctuations in these emerging economies and that these economies can’t shield themselves from news shocks by extending the maturity of their debt.

Now, back to FRED: Data can be used to test and illustrate the logic behind this research. The graph shows (in blue) the St. Louis Fed Economic News Index that’s used to predict the value of current real GDP before the BEA releases the official data. Assuming this index is good at capturing current news, we should see a strong correlation between this index and a financial index affected by the future performance of the economy. The index we chose (in red) is the S&P 500: This measure of the value of the stock market, as a measure of the expected performance of U.S. companies, serves as our measure of future performance.

The graph shows that the S&P 500 and Economic News Index move closely together, which suggests the logic is correct and that additional research could identify how news affects the U.S. economy.

How this graph was created: Search for and select “St. Louis Fed Economic News Index: Real GDP Nowcast.” From the “Edit Graph” panel, use the “Add Line” tab to search for and select the S&P 500 series; then click “Add data series.” From there (the “Edit Lines” tab), adjust the units to “Percent Change from Year Ago” for comparability with the news index. Now, both lines will be on the same graph, but their scales are quite different. To better compare the two, you can select “Format” and change the y-axis position to “Right” for the S&P 500 line.

Suggested by Ryan Mather and Juan Sánchez.

View on FRED, series used in this post: SP500, STLENI

The stock market is not the economy

Taking a "random walk" through the data

Does the stock market tell us anything about the economy? The stock market seems to react continually to various data and economic news, and many of us follow its day-to-day changes, especially if we’re invested in it. But do fluctuations in the stock market actually reflect economic health?

The best measure we have for measuring total economic activity is GDP. But GDP is measured only quarterly and with a considerable lag. With the help of FRED, though, we can look at a decade’s worth of data to see how closely GDP relates to the stock market.

The graph above looks at quarter-to-quarter percent changes in the Dow Jones Industrial Average (DJIA), deflated to remove general price increases, and real GDP, which is by definition also deflated to remove general price increases. Of course, the stock market is very volatile, but it’s too hard to see any relationship in this line graph. A better way to visualize connections (or a lack of connections) is a scatter plot, shown below, with the same data.

If the two measures were related, we would see the points clustered in the lower left, middle, and upper right. But we don’t see that. One reason may be that the DJIA covers only 30 firms. While they’re large firms, they make up only a fraction of the economy. So we built the same graph (below) with data from the S&P500, which encompasses the 500 largest firms on the stock market. But no luck: We still don’t see any relationship.

So why are GDP and the stock market graphically unrelated? First, it’s important to understand what the value of a stock measures: the sum of discounted expected dividends plus a liquidation value of capital. In other words, what the market thinks the future dividends of the firm will be, evaluated at current prices, and what could be obtained from liquidation if the firm goes bankrupt. Note that dividends are only a small part of the firm’s income; dividends don’t account for any income that’s directed toward taxes, servicing loans and bonds, and (maybe most importantly) wages. The labor income share of total income in the economy is about 60%. And, as recently noted on this blog, the labor income share has decreased. Now, if regulation or laws reduce the bargaining power of labor, for example, labor income decreases, capital income and dividends increase, but total income may not have changed or even decreased.

How these graphs were created: Search for “Dow Jones,” select the Industrial Average series, and click on “Add to Graph.” Click on “Edit Graph,” add the “GDP deflator,” apply formula a/b, and set units to “Percent change.” From the “Add Line” tab, search for and select “real GDP,” and set units to “Percent change.” Once you restrict the sample to the last 10 years, you have the first graph. For the second, take the first, use the “Edit Graph” panel to open the “Format” tab and select type “Scatter.” For the third graph, replace the DJIA with SP500. You can then expand the sample.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: DJIA, GDPC1, GDPDEF, RU3000TR, SP500


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