'Micro' Equity Focus Is Shifting To 'Macro' Bond Reality
Fixed income markets have always focused closely on news about the US macro-economy; while traditionally, equity market participants have focused more on the “micro” data – in particular, news about current and prospective corporate earnings – to form their views about the relative attractiveness of different stocks or the market as a whole. Goldman finds that the financial crisis changed all that. The responsiveness of the US equity market to economic news increased dramatically, now showing about twice as much sensitivity to macro data as it did in the years before the financial crisis. While micro data remains important - especially in quantifying just how much QE-hope the market is 'abiding' by, macro news is likely to be the critical driver of equity markets until the global economic outlook is considerably brighter than it looks today (or macro decouples from Fed/ECB jawboning). On average the market’s responsiveness to all these economic indicators suggests that we are still very much living in a macro world. In the meantime, there are some exceptions to the fairly consistent reactions to economic news that we see between equity and bond markets.
Goldman Sachs: Economic News and the Equity Market
Traditionally, equity market participants have focused more on the “micro” data – in particular, news about current and prospective corporate earnings – to form their views about the relative attractiveness of different stocks and about the market as a whole.
While equity market investors were certainly well aware of the major economic releases, they were often seen as just one part of the “mosaic” of information gathered by investors rather than a central driver of markets.
The financial crisis changed all that. The responsiveness of the US equity market to economic news increased dramatically during the crisis and has remained high since (Exhibit 1).
Assessing the Market Impact of Economic Data
The equity and bond markets show fairly consistent reactions to economic news, with a couple of notable exceptions. Stronger-than-expected news about growth pushes up both equity prices and bond yields, but stronger-than-expected news about inflation has the opposite impact on the equity market.
Bond markets appear to be more attuned to business survey data and relatively less responsive to news about consumer confidence or GDP. This is portrayed in Exhibit 4, in which the vertical axis measures only the average absolute response of the equity market to each indicator (i.e. we reverse the sign on the inflation data) and omits NFP.
Market Focus Varies over the Cycle
In general, the equity market appears to have shifted its focus in intuitive ways:
- News about housing activity was extremely important as this sector of the economy collapsed in 2007-2008, but moved markets much less before and since.
- Similarly, equity investors worried about upside surprises to inflation while the economy looked strong, but have paid relatively little attention to these data lately.
- Reports on consumer spending and confidence were extremely important in the early recovery, but seem to have received a bit less attention over the last year or two (Exhibit 8).
- Concerns about the global growth outlook and the still-weak labor market have kept markets very focused on news about the manufacturing sector and employment (Exhibit 9).
While the response of equities to economic data is generally straightforward—more growth and economic activity is good, more inflation is bad — there are some limited circumstances under which “good news is bad news” from a market perspective.
Towards the end of the business cycle, when inflation pressures and Fed tightening are a concern, markets may see especially strong activity data as a mixed blessing. This is evident in Exhibit 9, which shows that as of early 2007, the two-year trailing average response to employment data was negative (i.e. in 2005-2006, when the economy looked good, the equity market didn’t react well to stronger-than expected employment reports). But at most times, good news on employment or economic activity is also good news for the equity market.
Taking an average of the market’s responsiveness to all these economic indicators suggests that we are still very much living in a macro world. The equity market shows about twice as much sensitivity to macro data as it did in the years before the financial crisis (refer back to Exhibit 1). We suspect this will remain the case until the US and global economic outlook becomes considerably clearer.