GDP Growth and Stocks

This week fellow Seeking Alpha author Jeff Miller of NewArc Investments wrote

While the market is not a GDP futures contract, it does have a good long-term relationship with economic growth

This is something I had been thinking about for a long time: the direct relationships between GDP growth, stocks, bond yields and inflation. In order to quantify the specific GDP-stock market correlation, I went through the following exercise.

Using Federal Reserve data published for a 50 year period from 1960 to 2010, find the Pearson correlation coefficient for two data sets: Year over year change in nominal GDP, and Year over Year change in the average annual price level of the Dow Jones Industrial Average, both contemporaneously and lagged by one year. The reason for lagging is to try to determine whether stock prices lagged or were concurrent with economic growth.

The results: r value of .48 for concurrent stock data and .57 for lagged data. My interpretation is that there is an economic growth effect on stock performance, but it is weaker than I had suspected, and that there probably is some lag between growth and stock price movements.

Jeff made the observation that “there is incessant [and presumably unwarranted] skepticism” about stocks presently. Given my finding, I wonder whether this is simply a reflection of stock investors’ tendency to disregard economic data. It could also explain the observation that few economists are superstar stock investors (but they tend to be pretty good bond managers).

There is a lot more work to do in this area, though I imagine it’s already been done several times before…but I haven’t been able to find it. Anyhow, I enjoy doing this kind of quantitative analysis myself. It’s good practice to keep your math and inquiry skills up.

Next project: quantify the long term relationship between nominal GDP, inflation and bond yields.

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