Friday, November 27, 2009

Leading Indicators

Even though the below article focuses on trading frequencies, timesteps, they mentioned some interesting variables tested to forecast market moves.


... Now, let’s talk about ways to trade the S&P 500 on the basis of the U.S. Leading Indicators Index. The index is a composite of ten indicators that historically preceded peaks and troughs in the U.S. economy. The composition of the Index changes through time, and may include the following indicators: interest rate spread between a U.S. 10-year note and the Fed funds rate, average weekly initial claims for unemployment insurance, average weekly manufacturing hours, index of supplier deliveries (vendor performance), stock prices, and manufacturers' new orders for non-defense capital goods.

Next, to estimate the impact of the announcement on the price changes in the S&P 500, we conduct a regression analysis. This analysis can be performed using the regression functionality in the Excel. We regress the changes in the S&P 500 on different aspects of the event announcements.

From the regression results, we find that at the monthly portfolio rebalancing frequency, the S&P 500 moves in tandem with the previous month’s change in the leading indicator index with probability of 87%. Thus, if the leading indicator index increased in the previous month, S&P 500 is expected to rise this month.

At daily trading frequencies, such a relationship does not hold: neither prior nor concurrent changes in the leading indicators have any bearing on the daily changes in S&P 500.

At hourly frequencies, however, the price of the S&P 500 moves with the unexpected component of the announcement: if the actual figure announced is higher than the consensus, S&P 500 rises with 90% probability; else, if the actual leading indicator index shows lower values than the expected value, then S&P 500 is likely to fall. Our results are consistent with several academic studies written on the topic, including one published in 2003 in the American Economic Review, volume 93, "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," by T.G. Andersen, T. Bollerslev, F.X. Diebold and C. Vega.


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