Today we're examining the monthly Output Report wherein US macroeconomic data is used to strategically forecast* S&P 500 E-mini and 10-Year US Treasury Note front month futures prices.
We'll begin with Real Personal Income (RPI). RPI has been steadily increasing since the start of the series many years ago. Naturally, economic slumps have caused RPI to drop (most clearly during the latest financial crisis) but RPI tends to rebound quickly to resume its long-run, mostly-linear trend.
Taking a closer view of the past few years (teal) and multi-year-ahead forecast (red), we see RPI staying mostly inline with its long-term positive trend with positive expectations for up to 2018-Q3. Slight variations to this long-run trend are anticipated mainly due to seasonal variations and business cycle fluctuations.
Yet, these fluctuations aren't anticipated to pose any major impact on the long-run trend nor the economic story at hand: RPI growth. Interesting, and slightly subtle, is the fact that the forecasted trend for RPI is noticeably flatter than for the actual, historical data. This adds to the story in that RPI is growing, is expected to grow in the future, yet is expected to grow at a slower pace than in the prior decade or so. We currently have a 2016-Q3 RPI expectation of $15,738,296 (million).
Yet, while RPI is expected to increase for the foreseeable future, as noted above, the momentum of this increase is anticipated to decline to a post-recovery, year-over-year rate of about 0.50%-0.75%. RPI momentum has typically ranged between about -4.0% and 5.5% so our forecasted RPI momentum is not out of the bounds of historical experience. Yet, declining forecast momentum signal expectations of declining growth in the macroeconomy as a whole (especially around early-to-mid 2016). Thus, growth is still anticipated to occur, just at a much slower, post-recovery pace.
Another relevant measure of macroeconomic health is Real Retail Sales (RRS). RRS is an important measure of consumer activity and health which, itself, is a massive component in determining Gross Domestic Product. In essence, strong consumers mean a strong economy. Note that, rather than just reporting the retail sales series in its raw, nominal form, we inflation-adjust this series so we can examine consumer health in terms of constant purchasing power.
From a long-term perspective, RRS is a highly seasonal series with many regularly-reoccurring whipsaws reappearing near the transition from one year to the next (i.e. the Thanksgiving-to-New Years spending boom and bust). Yet, despite the whipsaws, RRS had been following a mostly-linear pattern of steady increases until the most-recent financial crisis, a bottoming out (locally) around mid-2009, and has been on a steady path higher ever since. Interestingly, retail sales are right about where they were, in an inflation adjusted sense, just before the last financial crisis and major macroeconomic contraction.
Looking at a close-up of the recent few years of RSS activity (teal) and the one-year ahead RSS forecast (red), we find a mostly-flat trend where Retail Sales have been surpassing general inflation by only small amounts. Looking at the year ahead, we see the same story: retail sales growth failing to significantly outpace inflation. This is evident if we examine where RRS currently is ($393,511 million; November 2015) and where RSS is expected to be by November 2016 ($401,829 million): about 2.11% higher.
Examining the RSS's year-over-year percentage change measure, a proxy for series momentum, we find that actual RRS momentum has been in decline since its local peak around mid-2013. This indicates that, while increasing, RSS is actually increasing at a decreasing rate (relative to prior years). In other words, consumers are still spending and the rate at which they spend (in constant dollars) is increasing. Yet, consumers have lost steam over the past few years indicating a general weakening in consumers and, by extension, the macroeconomy. Currently RSS momentum is hovering at about 0.5% with a relatively strong resurgence expected in the year ahead. In net, RSS momentum is expected to increase to a steady state of about 1.5% year-over-year.
We now shift our focus towards the financial markets and, more specifically, how our forecasting models are anticipating that measure of macroeconomic output will impact asset prices in the coming year. One of the many ways we do this is by looking at our "Marginal Economic Influence" (MEI) metric.
MEI measures the percentage difference between two forecasts. The first is a forecast without the macroeconomy explicitly incorporated into the forecasting model. The second forecast includes macroeconomic output variables directly in the forecasting model. So, taking the difference between the two forecasting models, one with and one without macroeconomic output included, gives us a measure of how the macroeconomy is anticipated to *incrementally* impact price.
For example, whenever we examine the one-year ahead forecast for the S&P 500 E-mini front month futures contract in our Strategic Report, you'll notice a grey line and a red line. The thin grey line represents the forecast without the macroeconomy's influence; the red line is a forecast with the macroeconomy's influence included. (As of mid-January, we are anticipating a mostly-flat trend in the S&P going forward through next year with a mid-January-2017 forecast of 2,009.65. Also, keep in mind that we believe that these forecasts represent the upper band of S&P growth and that significant downside risk exists in the year ahead.)
The difference between the two forecasts gives us the S&P's MEI. This chart can be interpreted in a fairly straightforward manner: "If the measure is above zero for a particular month, then the macroeconomy is anticipated to have a incrementally-positive impact on price. Conversely, if the measure is below zero for a particular month, then the macroeconomy is anticipated to have a incrementally-negative impact on price."
Looking at the S&P 500 E-mini's MEI, we see a mixed reaction where the macroeconomy is expected to have a positive influence in some months whereas, in other months, it is anticipated to have a negative influence. Most of the macroeconomy-to-S&P impacts tend to be positive with a net influence of about +0.5% per month. Two big exceptions are for March 2016 and April 2016.
Specifically, the macroeconomy is expected to have a strongly positive marginal influence (~ +2.5%) on the S&P in March with a strong negative marginal impact (~ -1.5%) in the following month, April. Given the S&P's positive correlation with the macroeconomy, this "excess" positive-to-negative reaction may stem from strongly positive macroeconomic news in March being followed by strongly negative macroeconomic new in April. Two culprits for this somewhat bipolar reaction could be the anticipated dip and reversals in Real Retail Sales and Real (Retail) Wholesale Inventories. If the S&P reacts in a positive way to the dip/reversal in these two series (i.e. March), it's likely that a reversion to that positive boost could occur in the following month (April). Regardless of the cause, this bears watching.
Looking at the 10-Year US Treasury Note price forecast, we are anticipating a general "W"-shaped trend over the next year where prices are expected to drop until around June, rebound until November, experience a short decline in December, and then rally back to November's levels in January. As of mid-January, we are anticipating a mid-January-2017 forecast of 130.85 (in decimals) for the 10-Year.
Examining the 10-Year's MEI, we see that the measure is mostly positive meaning that the macroeconomy is currently expected to positively impact 10-Year prices during most months. Yet, two strong reversals are anticipated for the February-to-April and November-to-January time periods. Specifically, the macroeconomy's marginal (read: "excess") impact for both of these periods starts quite positive but then dramatically declines (~ - 0.35% and - 0.40%, respectively) in the following month, only to reverse (once gain) to a positive level. Thus, traders need to be aware that the 10-Year is anticipated to be highly sensitive, and negatively so, to macroeconomic output news during the February-to-April and November-to-January months.
Thank you for your time and interest; we hope you have a profitable trading day!
Technical Note: All forecasts reported in this post and in Williams Analytics' Indicator Reports are generated from Williams Analytics' proprietary statistical forecasting models. Macroeconomic variable forecasts are based on the most-recent historical data possible on a quarterly or monthly basis, depending on the specific series at hand. Economic forecasts use own- trend, seasonal, and mean-reverting components in dynamically-adjusting time-series econometric models to find "optimal" t+k step-ahead forecasts. Note that each macroeconomic variable's forecast is independently estimated based on its own, "best fitting" model. Strategic price forecasts for various assets, e.g. the S&P 500 E-mini and 10-Year Treasury Note front month futures contracts, use the most-recent market observations available to provide monthly, t+k step-ahead statistical forecasts. In addition to using own- trend, seasonal, and mean-reverting components, Williams Analytics also includes higher-moment (e.g. volatility, etc.), inter-asset index, broad-asset index, and future macroeconomic expectation information (see above) in calculating each asset's independently-estimated, dynamically-adjusting time-series econometric model and associated forecast(s). All other reported macroeconomic and asset price information (e.g. volatility, year-over-year percentage change, Marginal Economic Influence, etc.) is based on both historical data and Williams Analytics' statistical forecasts.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.