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2019 presentation Connecting the Economy to the Stock Market by - - PowerPoint PPT Presentation

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Selected slides from March 18, 2019 presentation Connecting the Economy to the Stock Market by Lou Floyd Todays Outline Key question: what does the economic cycle actually look like? #1 problem in viewing economic and

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Selected slides from March 18, 2019 presentation

“Connecting the Economy to the Stock Market”

by

Lou Floyd

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Today’s Outline

  • Key question: what does the economic cycle actually look like?
  • #1 problem in viewing economic and market data: noise

– Essential to filter and scale all data before interpreting – Best comparison technique: YOY % change (rate-of-change – ROC) – Generates characteristic peak/trough patterns throughout cycle

  • Cyclic behavior: oscillations viewed over time

– Both economy and stock market exhibit cyclic behavior, broadly grouped as leading/coincident/lagging behavior vs. GDP [appears as

corresponding peaks & troughs shifted L or R on time scale]

– Stock market is among group showing leading economic behavior, but this is largely a reporting anomaly

  • In reality, economics are fundamental to all markets -- both

exhibit common peak/trough patterns

  • Unfortunately, outside interventions – regulatory, monetary,

fiscal, political – disrupt normal market tendencies and relationships

  • Caveat: all forecasts routinely lag actual behavior
  • Conclusions

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Definitions of Noise

  • Different cause from main signal

– meaningless bits that must be removed from a data stream in order to see underlying signal – random variation in data unrelated to underlying signal – natural variation in process

  • Total of all errors in the process of generating and recording a

result

– e.g. teachers / Aug ’07 emplymt – reminders:

  • errors multiply, not add
  • Error level (noise) reduced by sq rt of no. of observations
  • For time-based data,

– Seasonal variation is largest source of noise – noise inversely related to observation interval – time itself can be used as a filter.

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Synonyms for Noise

Background Static Error Variability Standard deviation Volatility

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Best Noise Filters

  • Year-over-year, rate-of-change

– {[(present - previous) / previous] * 100]}

– removes seasonality, the largest single source of noise – Ref: Joseph Ellis, Ahead of the Curve

  • Percentage (necessary for common viewing scale)
  • Use moving average for final smoothing (remove spikes)

– Weekly ~6 - 8 units – Monthly ~ 3 - 5 units – Quarterly ~3 units – Minimum is 3: most collection errors (ST spikes) are corrected in next time interval – helps one develop belief-sufficient-for-action (key barrier to action)

  • Note: aggregates much less noisy than components.

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Example of Noise Filtering

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  • 15%
  • 10%
  • 5%

0% 5% 10% 15% 40 60 80 100 120

J-80 J-82 J-84 J-86 J-88 J-90 J-92 J-94 J-96 J-98 J-00 J-02 J-04 J-06 J-08 J-10

Industrial Production

Cumulative M/M % Change 3MA M/M % Change 3MA Y/Y ROC

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Some viewing realities

  • Among various presentation forms,

– Cumulative data contain the least useful information – Change from preceding interval contains the most noise

  • YOY % change format

– Contains the most useful and reliable information – removes seasonal variation, the largest single source of noise.

  • Amplitudes are far less important than occurrence of peaks

and troughs (trend changes)

  • Troughs are far more reliable than peaks for identifying trend
  • changes. [far better defined]
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Cycle Terminology

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  • Economic terminology (NBER):

– Recession: the decline portion

  • f the recession trough

(A B) – Turn-around: the bottom of the recession trough (B) – Recovery: the upswing after the bottom of the decline (B C) – Caveat: often different from what it “feels” like

  • Note: Commentators frequently

misuse the term “recovery” to mean something well up the recovery portion -- sometimes even point C and beyond – whatever serves their own ends.

A B C

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SLIDE 9

Concept of Economic Cycle

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From Ellis, Ahead of the Curve

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Gross Domestic Product (GDP)

  • Sum of market value for all goods and services produced by labor and

property located in the USA. Consists of:

– personal consumption expenditures (G&S purch by US residents), – gross private domestic investment (fixed invstmt plus δ inventories), – net exports of goods and services, – government consumption expenditures and gross investment.

  • Includes:

– Foreign residents and foreign capital employed in USA – Output of not-for-profit organizations – Both new and used goods

  • Excludes:

– G&S produced by US citizens and capital located outside the USA; – intermediate purchases of goods and services by businesses; – Imports.

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Composite Indicators

  • The economy (GDP) is the sum of all businesses

– thousands of companies – Dozens of components (sectors, industry groups) – Both manufacturing and services

  • Those components follow a natural sequence in time:

RM purchases pdn of G&S new cap invst income

  • This sequence is commonly simplified into three groups:

leading coincident lagging

  • Indicators can be utilized to describe (detect) those three

behaviors – but they do not cause those behaviors.

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  • 40.0%
  • 30.0%
  • 20.0%
  • 10.0%

0.0% 10.0% 20.0% 30.0% 40.0%

  • 20%
  • 15%
  • 10%
  • 5%

0% 5% 10%

J-00 J-01 J-02 J-03 J-04 J-05 J-06 J-07 J-08 J-09 J-10

FLF Composite Economic Indicators

Expanded Scale

Coincident Lagging Leading For major troughs: Leading: left of coincident (earlier) Coincident: middle (white) Lagging: right of coincident (later) Differences: 3 to 9 months

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“Substitutes”

  • “Surrogate,” “proxy” and “indicator” are all terms used to

suggest that something else of interest is also likely to be

  • ccurring.
  • They are said to be a substitute for the item of interest, and

are employed because of their ease of discovery relative to the actual item of interest.

  • Such indicators are only useful if they are highly correlated

with the desired result. [obtained through a feature count]

  • However, this does not require that a cause-effect relationship

exists between them – only that they occur in similar time frames.

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  • 15%
  • 10%
  • 5%

0% 5% 10% 15% 20%

J-80 J-82 J-84 J-86 J-88 J-90 J-92 J-94 J-96 J-98 J-00 J-02 J-04 J-06 J-08 J-10 J-12

Monthly Surrogates for GDP

Industrial Production Sum of Coincident Indicators GDP 2 per. Mov. Avg. (GDP)

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References

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Sources of Free Economic Data

  • Hard

– Economic data

  • Department of Commerce (NBER)
  • Department of Labor (BLS)
  • Federal Reserve Banks (www.research.stlouisfed.org/FRED2)

– Stock market closing data (Yahoo; markets; some brokerages)

  • Soft

– Employment / unemployment (household survey -- DOL) – Purchasing Managers Index, Deliveries, bsns activity (ISM) – Consumer sentiment/confidence

  • Univ. of Michigan (best)
  • Conf. Board (decent)
  • AAII (least useful)
  • Derived

– Savings – monetary

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Some Useful References

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