Sunday, January 31, 2016

Business Cycles and the Stock Market

Business Cycles and the Stock Market
In 2007, the commodity bubble contributed to the Great Recession. The information technology bubble, in the late 1990s, was followed by a recession. These observations bring this question: how do business cycles, i.e. alternating economic expansions and recessions, relate to fluctuations in the various sectors of stock market?

To answer for this question, I have analyzed monthly gross domestic product (GDP) in Canada and Standard & Poor's (S&P) indices of various sectors of Toronto Stock Exchange (TSX).

S&P/TSX Indices and GDP, Canada, 1998:M1-2015:M11

In Canada, an effect of the Great Recession was a continuous fall in GDP from Octobeer 2008 to May 2009. At the same time, over six consecutive months starting from September 2008, the stock market plunges. Stocks in the sector of diversified metal and mining lost 62.75% of their values. In the energy sector, they lost 51% of their values. In both the information technology and industrial sectors, the value of stocks plummetted by about 44%. Only the gold sector grew by 9.26%. The lost in the consumer staples sector was much lower (4.94%).

In Canada, a slow down followed the burst of the information technology bubble. Between August 2000 and September 2002, in the information technology and telecommunication service sectors, stocks lost respectively 90% and 56% of their values. Stocks were worth 30.6% less in the consumer discretionary sector. Sectors that outpoerformed were the gold (+85.6%), consumer staples (+65.2%), utilities (+39.9%), and energy (+33.6%).

The table below shows how the various sectors of the stock market fluctuate over the business cycle. Business cycle is measure as short-run fluctuations in GDP.

Cyclical Behavior of the Stock Market and GDP, Canada, 1998:1-2015:M11

Sector % Standard Deviation Correlation with GDP
S&P 60 9.84 .57
Consumer Discretionary 8.85 .44
Consumer Staples 5.95 -.08
Energy 12.63 .41
Financial 10.25 .25
Gold 12.91 -.05
Industrial 11.06 .48
Information Technology 21.84 .39
Material 11.45 .36
Diversified Metal Mining 21.65 .29
Telecommunication Service 12.08 .5
Utilities 8.07 .21
GDP .87 1

  • The stock market is procyclical, i.e. positively correlated with the business cycle, except the sectors of consumer staples and gold.
  • The stock market is more volatile than the real economy.
  • The most volatile sectors of the stock market are: the information technology and the diversified metal and mining.

In most sectors, the stock market leads the business cycle by three months.

The dataset used is available here