SPY And U.S. Economic Index Both Spike In November

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Summary

The SPDR S&P 500 ETF ascended to an all-time high in November, while my U.S. Economic Index climbed to a near-record tier.

In October, the behaviors of the exchange traded fund and my economic indicator diverged for the first time in three months.

The correlation coefficient between the two metrics over the lifetime of their relationship is now 0.67.

The SPDR S&P 500 ETF (NYSEARCA:SPY) achieved its second consecutive adjusted all-time closing monthly high in November, as it advanced to $207.20 from $201.66, a gain of $5.54, or 2.75 percent. Meanwhile, my U.S. Economic Index approached its own loftiest level, as it grew to 59.23 from 57.34, an increase of 1.89 points, or 3.29 percent. The USEI is therefore within spitting distance of its peak reading of 59.53, which was registered in August.

I developed my USEI in an attempt to capture all American economic activity in a single monthly figure I could employ as a guide in my financial market operations. I founded it mainly on Institute for Supply Management manufacturing and non-manufacturing numbers, as discussed in the blog post introducing the metric at J.J.'s Risky Business.

Figure 1: SPY, USEI Monthly Values, January 2008-November 2014

Note: The SPY adjusted closing monthly share price scale is on the left, and the USEI monthly value scale is on the right.

Source: This J.J.'s Risky Business chart is based on proprietary analyses of ISM data and Yahoo Finance adjusted closing monthly share prices.

ISM published its latest manufacturing data Monday and its latest non-manufacturing data Wednesday. It has reported the relevant figures in the former series since January 1948, but has reported the relevant numbers in the latter series since just January 2008. Accordingly, the complete data set for the USEI covers only 83 months (Figure 1).

I calculate the SPY-USEI correlation coefficient as 0.67 during this period. The comparable statistics were 0.66 for October, 0.65 for September, 0.64 for August, 0.63 for July and 0.61 for each of the four months between March and June. As a result, the coefficient has risen five months in a row.

Figure 2: SPY-USEI Correlations, January 2009-November 2014

Note: I basically consider as a baseline the first 12 SPY-USEI correlation coefficients, so I have excluded them here.

Source: This J.J.'s Risky Business chart is based on proprietary analyses of ISM data and Yahoo Finance adjusted closing monthly share prices.

During the USEI's first 57 months (i.e., before the dawn of the Federal Reserve's most recent quantitative easing program, aka the Age of QE3+), the USEI acted primarily as a leading indicator and secondarily as a coincident indicator of SPY's movements. I calculate the SPY-USEI correlation coefficient as 0.75 in this period.

Shortly before and shortly after the dawn of the Age of QE3+, this same statistic quantified an observable positive correlation between the equity market and the economy that was both stable and strong, with the SPY-USEI coefficient calculated as 0.75 for each of the six months from July to December in 2012 (Figure 2).

Over the past 26 months (i.e., after the dawn of the Fed's Age of QE3+), there was a breakdown in the SPY-USEI relationship, indicating a disruption in the continuous feedback loop between the stock market and the economy. As a result of this disruption, I now consider the USEI solely as a coincident indicator of SPY's movements.

I calculate the SPY-USEI correlation coefficient as 0.53 in this period. The comparable numbers were 0.46 a month ago, 0.42 two months ago, 0.35 three months ago, 0.19 four months ago, 0.03 five months ago, -0.07 six months ago, -0.22 seven months ago and -0.30 eight months ago.

This nine-month trend suggests substantial progress in the normalization of the relationship between the economy and the market.

Figure 3: USEI Monthly Values, 2014 Versus 2010-2013 Mean

Note: The current expansion began in June 2009, according to the Business Cycle Dating Committee of the National Bureau of Economic Research.

Source: This J.J.'s Risky Business chart is based on proprietary analyses of ISM data.

The USEI was an underachiever to a significant degree in 2014's initial three months and an overachiever to an even more significant degree in the year's most recent seven months, when compared with the relevant mean values compiled for the months between January and November during the first four full years of the current expansion (Figure 3).

On one hand, I was completely unsurprised by the USEI's level for each of the first 10 months of 2014. On the other, I was completely surprised by the metric's reading for last month. Thirty days ago, I anticipated that this number would be flattish, maybe up a little, perhaps down a little.

Clearly, the conditions contributing to the USEI's behavior in November will do nothing to derail a Federal Open Market Committee on track to announce its first interest rate hikes in almost nine years as soon as April 29, about six months after the Federal Reserve concluded asset purchases under its most recent QE program.

Figure 4: USEI Monthly Values, 2014 Versus 2010-2013 Median

Source: This J.J.'s Risky Business chart is based on proprietary analyses of ISM data.

The USEI also was an underachiever to a significant degree in 2014's initial three months, and an overachiever to an even more significant degree in the year's most recent seven months, when compared with the relevant median values compiled for the months between January and November during the first four full years of the current expansion (Figure 4).

Figure 5: USEI Monthly Values With 3-Month And 12-Month SMAs

Source: This J.J.'s Risky Business chart is based on proprietary analyses of ISM data.

The USEI's 12-month simple moving average of 56.02 in November is gliding over all comparable levels in the charted data set (Figure 5), which means every Breaking Bad fan in the world has to be wondering whether its ascent to the heavens will result in a conclusion like the one associated with Walter White.

Along this line, I note the three next-highest USEI 12-month SMAs observed previously were 55.73 in March 2011, 55.72 in April 2011 and 55.63 in May 2011. All three came around the time QE2 ended, and around the time the last SPY bear market began.

Despite the USEI's unanticipated strength last month, it indicates growth in gross domestic product will be weaker in the fourth quarter than it was in the third quarter.

Based on trends in its trade credit insurance business, Euler Hermes SA (OTC:EURHY), a unit of Allianz SE (OTCQX:AZSEY), also has developed this expectation. A couple of weeks ago, the company reported there had been no year-to-date improvement in the number of past-due payments to U.S. businesses, and that the average dollar amount of such past-due payments during the first three quarters of the year increased by about 2 percent from 2013 to 2014.

Founded on a strong correlation between GDP and payment behavior, Euler Hermes forecast GDP growth in Q4 likely would fall to about 3.0 percent. Meanwhile, the U.S. Bureau of Economic Analysis estimated GDP growth in Q3 was 3.9 percent.

Given the continuing normalization of the relationship between the economy and the market, as represented by the monthly movements of the SPY-USEI correlation coefficient, I suspect monitoring of real-world conditions is more important now than it has been at any time in the past two-plus years.

Disclaimer: The opinions expressed herein by the author do not constitute an investment recommendation, and they are unsuitable for employment in the making of investment decisions. The opinions expressed herein address only certain aspects of potential investment in any securities and cannot substitute for comprehensive investment analysis. The opinions expressed herein are based on an incomplete set of information, illustrative in nature, and limited in scope. In addition, the opinions expressed herein reflect the author's best judgment as of the date of publication, and they are subject to change without notice.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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