Share Price Drop is not about NGDP Expectations

tldr: Don’t worry

When developing our NGDP forecasting methodology, which uses only data from the NGDP/NGDI time series as well as market prices, we ran a number of validation trials. These trials sought to show that the methodology was invalid. We did simulation studies, we did out of sample tests and weren’t able to find a problem, though the most impressive result came when we ran the system in a simulated daily forecast update against the ’87 stock market crash.

The “Black Monday” crash of October 19, 1987 saw the S&P 500 drop 20% in a single day. However, nothing really happened in the macro economy. Greenspan talked down the dollar (massively), cut rates and life went on, there wasn’t even a sign of a slowdown in macro data. When we ran a version of our system (without TIPS spreads, which didn’t exist at the time) against the Black Monday financial data, NGDP growth showed a small downward blip, but nothing too crazy, nothing like the massive collapse in expected NGDP that occurred when we ran our system against the daily observations from September-2008 through March 2009.

If NGDP expectations are a ‘thing’ that exists in the Collective Unconscious of market participants (and we think this is a useful approximation) then that ‘thing’ is not synonymous or even principally composed of equity price related factors. Or, to put it in reverse order, NGDP expectations do not always drive stock prices, this is how share prices can rise 50% since the election and the economy doesn’t really grow too much faster.

This is exactly what happened yesterday. Somewhat reminiscent of the recent collapse in crypto currency prices, though so far not nearly as dramatic, the S&P 500 fell 4.1%, which is indeed a big drop for a single day. However, our forecast has only fallen 0.06 percentage points, to 4.35%, it’s just another wiggle in the line.

 The bearish move by stocks was mirrored across most asset classes, but the moves just weren’t big enough to matter. Importantly, TIPS spreads actually rose, as did the 5-year yield, and the short end of the curve didn’t drop too much, though the 2 year yield did dump about 15 basis points. The dollar index didn’t move and copper prices even rose. West Texas Intermediate fell but it is still at $63 a barrel. This isn’t a market that’s screaming “recession”, but rather “4.35% nominal growth”.

We don’t know why the stock market fell today. Some say it’s because Trump is planning a coup against the Deep State. Others say it’s because the Deep State is planning a coup against Trump, and others still that it’s because immigration reform is (so this story goes) more likely, which will reduce corporate profits through a higher labor share of GDP and slower population growth. Who knows? What we can say is that, given what we know now, there is no reason to worry about the outlook, things still look about as they have for the last month or so, a little bit faster growth in 2018 than in 2017. Don’t listen to the financial media, who fan the flames to steal your time and attention. There´s nothing here yet.


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