The stock market is no crystal ball into the economy’s outlook
ONE of the great Wall Street parlor games is trying to divine what the stock market is telling us about the future of the economy. That's especially true in a market like this one, which is down sharply for the year, the occasional daily uptick notwithstanding. After all, the thinking goes, if today's stock prices reflect what investors are willing to pay today for a stream of future earnings, there's a macro-economic message lurking in there, right? Allan Sloan is a columnist for The Washington Post. He is a seven-time winner of the Loeb Award, business journalism's highest honor. View Archive Probably not. No, I'm not going to use the old line about falling stock markets having predicted 11 of the past five recessions. Instead, I'll show you how little weight is accorded to stock prices by serious economists whose job is to estimate the future course of the economy. I'm talking about the Conference Board Leading Economic Index, often known by its former name, the index of leading economic indicators. The Standard & Poor's 500-stock index is, in fact, one of the 10 factors that Conference Board economic techies use to construct the Leading Economic Index, which we'll call LEI from here on. But the S&P's influence on the LEI is remarkably light.
Month-to-month changes in the S&P account for only 3.97?percent of the change in the 10-factor LEI. By contrast, changes of average weekly hours of manufacturing workers account for 27.41?percent of the change in the index. And average consumer expectations for business conditions tallies 14.59 percent. The S&P ranks eighth of the 10 factors, ahead of only two other factors, both of which are frequently treated like some sort of economic divining rod: average weekly initial claims for unemployment insurance (3.29 percent in the LEI) and building permits for new private housing starts (3.10 percent). How can popular news-making indicators such as the S&P, unemployment claims and housing starts rank so low on the index, with a combined weight less than the spread between federal funds and 10-year Treasury securities (11.15 percent)? "The LEI is an objective and reliable tool for forecasting the economy," Ataman Ozyildirim, the Conference Board's director of business cycles and growth research, told me. Stock prices, he said, "are a very important indicator, but they're very noisy" and often reflect herd behavior and momentum, as opposed to rational assessments by investors looking at projected future earnings and asset prices.