From Lu Wang, “There is an optimistic sign…” Bloomberg (Jan 18, 2023):
It is as close to a sure bet as the markets have ever offered. When the S&P 500 is down 20% or more, a recession is near. But economists whose fervent calls for 2023 are being informed by this signal should look deeper at last year’s rout before betting the farm on it.
New analysis by researchers at Banque de France and the University of Wisconsin-Madison shows that treating the market as a whole when evaluating its economic signals is less effective in part because benchmarks like the S&P 500 can be skewed by companies with rich prices or those that derive revenue from them. overseas. Industrial stock performance and value serve as a better predictor of future growth, according to the study, which covers the period from 1973 to 2021.
The paper in question is Chatelais, Stalla-Bourdillon, and Chinn, “Forecasting Real Activity Using Stock Market Information Across Sectors,” Journal of International Money and Finance (March 2023), discussed in this guest post. The predictive power of a factor based on ranked stock indices outperformed the 10-year-3-month difference and the overall stock index.
Figure 2 Out-of-sample RMSE from different estimated models
NB: On the graph the out-of-sample RMSE is represented for different models (factor model or univariate regressions that depend either on the total DY, on the late IP growth or on the diffusion term). The expected variable is IP growth over 12, 18 and 24 months.
The article concludes:
Strategists at Barclays Plc including Venu Krishna have maintained a model that tracks equity leadership and business cycles and, by comparing them over time, seeks to provide insight into the market’s assessment of the state of the economy. Now, the verdict is clear: no recession.
Unfortunately, as of July 2022, our model projected a 2.2% decline in industrial production, in contrast to positive expectations from the range spread and the somewhat divided total yield in contrast to the sunny conclusion from Barclay’s Plc. As of December, the IP address in the United States decreased by 0.5 points compared to June 2022.