It would be nice if sector share prices anticipated economic trends

By October 17 2012, 9:41 pm 4 Comments
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There is some evidence – but not a lot – that the stock market anticipates trends in economic activity, pruning back share prices when a downturn is expected and cautiously lifting those prices back upwards when better times are seen to be on the horizon.

The accompanying chart compares quarterly movements in GDP with the MSFI Index of marketing company UK share prices.  There is some indication that, in the past, the share prices started moving in a new direction a few months before the economy changed direction.

If this evidence has any validity it would suggest that we are about to enjoy a period of economic recovery.  Share prices have been moving upwards while the economy is still bumping along its depressed path.
One factor affecting the current improvement in the industry share price index is the demise of the poorest performers – companies like Adventis Group and Media Square.  Thus the index is now benefiting from the better quality of its composition.

But maybe we are also seeing the first hint of a return to a more optimistic business mood.  That would be a pleasing thought, although the evidence is fragile and only time will tell whether a simple chart can be taken even a mite seriously.

Bob Willott is editor of “Marketing Services Financial Intelligence”

  • Mano Manoharan

    Interesting observation you make Bob
    However there could be a simpler (but or so much more tedious to explain) macro economic explanation for the share price hike you have observed – and that’s down to the increased ‘yield gap’ between equity and bonds. 
    The ’yield gap’ is the difference in the comparative yields of safe Government bonds and riskier company shares. Investors will expect to earn a better yield to hold onto company shares.

    All the Quantative Easing (QE) that monetary authorities have been pursuing in UK, US and Europe (buying Government debt with newly minted money) has resulted in boosted bond prices (due to more demand) and hence dramatically lower bond yields – because bonds pay out a fixed interest amount. 

    That is the goal of the QE policy – to force down interest rates.

    This has then served to widen the yield gap between bonds and shares – and make shares a more attractive investment, compared to bonds. 

    Hence Investors have been piling into shares – which then has the effect of lifting the equity market (and reducing the yield gap…)

    Phew, 
    I can put my ‘A’ level Economics notes back into the binder…!

  • Mano Manoharan

    Interesting observation you make Bob

    However there could be a simpler (but or so much more tedious to explain) macro economic explanation for the share price hike you have observed – and that’s down to the increased ‘yield gap’ between equity and bonds. 

    The ’yield gap’ is the difference in the comparative yields of safe Government bonds and riskier company shares. Investors will expect to earn a better yield to hold onto company shares.

    All the Quantative Easing (QE) that monetary authorities have been pursuing in UK, US and Europe (buying Government debt with newly minted money) has resulted in boosted bond prices (due to more demand) and hence dramatically lower bond yields – because bonds pay out a fixed interest amount. 

    That is the goal of the QE policy – to force down interest rates.

    This has then served to widen the yield gap between bonds and shares – and make shares a more attractive investment, compared to bonds. 

    Hence Investors have been piling into shares – which then has the effect of lifting the equity market (and reducing the yield gap…)

    Phew, 

    I can put my ‘A’ level Economics notes back into the binder…!

  • ROBERT WILLOTT

    Thanks Mano.  Would your explanation also apply to previous peaks and troughs?  And can you explain why the MSFI Index (marketing shares) is so much more closely aligned with the economic peaks and troughs than the FTSE All-Share Index (overlaid on the revised chart I’ve uploaded) that one would expect to reflect your QE explanation?

    • Mano Manoharan

      I put my ‘A’ level Economics binder away…(and refuse to get it out again!)
      But I can add that I have never been a ‘Chartist’.

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