Several days ago, the Commerce Department reported that factory orders in May increased 2.9 percent. This was well covered by the ‘press’, as it was supposed to have a positive effect on the ‘market’ (yes, the prices are intentional…..you’ll see why). The enthusiasm was understandable – $394 billion in orders for manufactured goods is the highest level seen since the current calculation method was adopted. Although skepticism can be wise, the number was (and still is) evidence that the economy is on a solid footing. However, very often there is a disconnect between what “should” be the result of a piece of economic data, and what is actually happening. The economy is not the market. Investors cannot buy shares with factory orders…… they can only buy (or sell) shares. No matter how strong or weak the economy is, one makes money just by buying low and selling high. In doing so, we have compiled a study of some economic indicators that are treated as if they affect stocks, but in reality they may not.
Gross Domestic Production
The chart below plots the S&P 500’s monthly versus quarterly GDP growth. Keep in mind that we’re comparing apples to oranges, at least to a small degree. The S&P should rise in general, while the GDP percentage growth rate should remain somewhere between 0 and 5 percent. In other words, the two will not move side by side. What we are trying to explain is the relationship between good and bad economic data, and the stock market.
Take a look at the chart first, then read our thoughts directly below. Incidentally, the raw GDP figures are represented by the thin blue line. It’s a bit erratic, so to make it easier, we’ve applied a 4-period (1 year) moving average to the quarterly GDP number – that’s the red line.
S&P 500 (Monthly) vs. GDP Change (Quarterly) [http://www.bluegrassportfolio.com/images/070705spvsgdp.gif]
Overall, the GDP number was a pretty poor tool, if you use it to predict stock market growth. In District 1, we see a significant economic downturn in the early 1990s. We’ve seen the S&P 500 drop about 50 points over that period, even though the drop actually happened before the GDP news came out. Interestingly enough, this “terrible” GDP number led to a full market recovery, and then another 50 pips rally before testing the upside. In Region 2, a GDP that exceeded 6 percent in late 1999/early 2000 was about to usher in a new era of equity gains, right? mistake! The arrows were crushed after a few days…and continued to be crushed for over a year. In District 3, the fallout from the bear market meant a negative growth rate by the end of 2001. That could go on for years, right? Wrong again. The market bottomed out right after that, and we’re a long way off the bottom of that economic downturn.
The point is, just because the media says something doesn’t make it true. It may matter for a few minutes, which is great for short term trades. But it would not be accurate to say that it is important even in terms of days, and it certainly cannot be important for long-term charts. If anything, the GDP number can be used as a contrarian indicator…..at least when it hits the extremes. This is why more and more people are abandoning traditional logic when it comes to their investment portfolios. Just paying attention to the charts is not without its drawbacks, but technical analysis would have gotten you out of the market in the early 2000’s, and back in the market in 2003. The final economic indicator (GDP) was lagging behind the market trend in most cases.
The unemployment
Let’s look at another well covered economic indicator……unemployment. This data is released monthly, rather than a quarterly release. But like the GDP data, the percentage will fluctuate (between 3 and 8). Again, we won’t be looking for the market to reflect the unemployment numbers. We just want to know if there is a correlation between employment and the stock market. As mentioned above, the S&P 500 is shown above, while the unemployment rate is shown in blue. Take a look, then read below to get our thoughts here.
S&P 500 (MoM) vs. Unemployment Rate (MoM) [http://www.bluegrassportfolio.com/images/070705spvsunemp.gif]
See anything familiar? Employment was strongest in District 2, just before stocks fell. Employment has been at its worst lately in District 3, just as the market ended the bear market. I highlighted a high and low unemployment range in Region 1, only because neither of them seemed to influence the market over that period. Like the GDP number, unemployment data is almost more appropriate to be a contrasting indicator. However, there is one thing worth noting, which is evident in this graph. While unemployment rates at the “extreme” ends of the spectrum have often been a sign of reversals, there is a good correlation between the direction of the unemployment line and the direction of the market. The two usually move in opposite directions, regardless of the current level of unemployment. In this sense, logic has at least a small role.
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You might be wondering what all the chatter is about economic data in the first place. The answer is simply to highlight the fact that the economy is not the market. Many investors assume that there is a certain cause and effect relationship between one and the other. There is a connection, but it usually doesn’t make the most sense. We hope the above charts have helped make this point clear. This is why we focus so much on charts, and are increasingly reluctant to incorporate economic data in the traditional way. Just something to think about the next time you’re tempted to react to economic news.