Are Markets Leading or Lagging Indicators ?

Obbh842_hotnot_20080418191257 Everyone "knows" that markets are leading — not lagging — indicators.

But are they really? It always gets stated so unequivocally that price contains information — and I do not disagree with that belief.

However, I am not so sure it contains all the specific information that is often claimed. Indeed, we see short term market action used to bolster arguments in a terribly one-sided fashion all the time. When it goes this way, it is significant and meaningful; When it goes that way, well, not so much. It is a thesis applied  inconsistently at best.

So are markets truly leading indicators?  

I have a nuanced theory, and it goes something like this: There are so many varied inputs into equity markets — sentiment, trend, liquidity, momentum, valuation — anyone of which can be dominant at any given moment.  Merely assuming markets are giving you a 6 month heads up into the future, based on recent action, is often unwarranted. There are simply too many examples where market prices are shown to be, oh, let’s be generous and call it subject to misinterpretation.

Equity markets can and do provide some insight — but they require careful interpretation, avoidance of broad generalities and oversimplifications. Unfortunately, that is often the stock in trade of many financial television shows and their T-head guests.

Let’s take a look at some recent market action, and see what it might or might not be forecasting:

China_20080418As the table above shows, this week saw US indices up between 4-5%. Many Bulls have seized on this as proof that the recession is now over, or will be soon enough. All clear! Its safe to get back in the water.

On the other side of the world, China’s stock market has been cut in half over the past six months. Are their markets forecasting, as some Bears proclaim, that a worldwide economic slowdown is occurring?

Aren’t these two beliefs rather inconsistent?

One of my favorite historical examples are the stocks of the Homebuilders. On their long, 75% decline, each and every rally attempt was seized on by housing bulls (usually parroting something Cramer said), proclaimed the bounce as proof positive that the Housing bottom was now in.

That turned out to be a very expensive misinterpretation of markets as a leading indicator.

Let’s go back to the turn of the century: In late 2000, markets rallied right into the start of the recession; they sold off right into its end in October 2002 — just as the recovery was beginning.

Here’s one last chart, via Portfolio’s Zubin Jelveh. Note that Consumer spending, GDP and Employment all peaked long before the October 2007 market highs.

Business Cycle Leads Equities

courtesy of Portfolio


So, are markets leading or lagging Indicators ?

My answer is that
they can be both. But getting the correct interpretation involves careful review of the charts, sentiment reads, liquidity, momentum, market internals, and other data. 

Insightful interpretation often yields clues, but is
fraught with the possibility of error.


The John McCain Market Selloff

China Stocks, Once Frothy, Fall by Half In Six Months
JAMES T. AREDDY in Shanghai, CRAIG KARMIN in New York
WSJ, April 19, 2008

Chart of the Day: The Business Cycle in Action   
Zubin Jelveh   
Portfolio, Mar 7 2008 12:59pm

Bloomberg TV has a special "China Focus Week” starting Monday, April 20th

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  1. lurker commented on Apr 19

    How about this? Markets are markets and indicators are indicators! Predictions are tough, particularly when they are about the future…I don’t think anyone is saying the recession is over because the market had a short-covering rally this week (okay a few morons maybe). It is really a question of depth and duration. We are going down (massive layoffs just getting going) but no one knows for how long or how bad it will get. Or how much of the globe goes down with us…we can argue all we want but NOBODY knows the future and all bets should be placed accordingly. The new highs list is packed with oil and oil service names, I will say that. And as for the Chinese market, isn’t 50% a Fibonocci retracement point? Good luck and good trading to all.

  2. bsneath commented on Apr 19

    Chicken or egg time.

    Do markets lead because of the precognitive abilities of investors, or do markets lead because of the wealth that is either added or taken away?

    Perhaps market prices are dictated more by interest rates and levels of leverage, and the ability for markets to “lead” is a result and not a prediction.

  3. Judy commented on Apr 19

    It sounds dumb but could it just be that in the dearth of good investment alternatives (what with skyhigh commodities etc) funds have decided rather than twiddling thumbs they might as well take a chance on equities, after all, they have investors to please and ultimately interest rates to pay (aassuming they had leverage)

  4. VennData commented on Apr 19

    There’s a certain amount of emotional self-reinforcement in day-to-day bids. That, coupled with computer millisecond trading making up half of the daily volume means interpreting the stock market’s short term moves as having meaning is error-prone.

    If the stock market, or anything, became a sure-fire indicator, it would stop being one. Such is the nature of markets.

  5. lurker commented on Apr 19

    Venn just said it better. drats. thanks VD!

  6. Ross commented on Apr 19

    I’ll take a shot for what it’s worth.

    Prior to 1980, there was a banking regulation aptly named Ragulation Q. It was put in place in 1933 with the passage of Glass-Steagel and put limits on interest rates both charged by S%L’s and paid on demand deposits by banks. In effect they were interest rate controls.

    Reg Q was a mighty weapon in the Feds toolbox. If in their opinion, the economy was too hot, they would dis-intermediate the banks. Once inventories were corrected or just prior to a recession, they would almost on cue re-intermediate. These actions were somewhat predictable and could in some measure be anticipated by the market.

    The banking reform act of 1980 allowed the financial system many leeways that they enjoy (at their collective peril) today. The repeal of Glass Steagalin 1998 ushered in almost total decontrol of the system and lack of any self or authoritive discipline.

    To answer the question, markets used to be somewhat anticipitory but no more.

    Actually, I made an observation in 1971 about the ‘Presidential cycle’ and how our financial system was at that time subject to modest political manipulation. Times have changed.

    Sorry for the tome. I need a life!

  7. ndallasj commented on Apr 19

    Actually, the rate of growth of consumer spending, GDP, and employment peaked prior to 07, not the actual levels. Hence, the decline in equities since late 07 may still be a valid leading indicator for declines in the level of economic activity. Is the current rally is an indicator of recovery or merely a fluctuation? …too soon to tell.

  8. m3 commented on Apr 19


    i think it’s just another extension of rational expectations/EMH /economists-are-oh-so-smart-that-we- can-predict-anything type nonsense.

    markets just give a price for the present supply and demand conditions at any given moment.

    commodities futures markets, on the other hand, are probably a better gauge. but only when taking backwardation (higher future demand) and contango (lower future demand) into consideration.

    markets did a lousy job forecasting the housing debacle.

  9. m3 commented on Apr 19

    Perhaps market prices are dictated more by interest rates and levels of leverage, and the ability for markets to “lead” is a result and not a prediction.


    when bernanke cuts interest rates on options expiration, and the dow screams higher, how would that be classified? lagging? leading? or market manipulation?

    rate cuts = more leverage = higher prices != economic forecasting.

  10. bsneath commented on Apr 19


    I very much want to reinvest in China – long term growth prospects and a devalued Yuan that should appreciate 100% over the next 5 years. Am worried however that China’s efforts to quell inflation will result in equity valuations continuing to fall. Also I’m concerned with what appears to be an increasing level of central planning dictates into the market economy. Your thoughts?

  11. lurker commented on Apr 19

    my thoughts? I have plenty, but they always seem to lose me money. I was commenting on the chart only as I do not think anyone can predict what the Chinese will do (investors or their government). Please do not take my advice as my opinion means nothing to the market. I was just making a comment about the chart and I do NOT trade so my opinion is even less valuable. Best of luck to you and always trail a stop in case you are wrong….but thanks for asking!

  12. Rich Shinnick commented on Apr 19

    The market is female. Barry, neither you nor I are ever going to figure it out-but we just might get lucky from time to time.

  13. Will Rahal commented on Apr 19

    Typically Markets lead.

    It is still very tricky to determine if a reversal in the real economy is to be expected with reversals in the markets, since markets have periodic corrections and tend to go to extremes.

    Talking about extremes, I expect an imminent
    correction in commodity prices.

    I have posted charts on the relative performance of PPI components such as Finished Goods, Intermediate & Crude Materials.
    We have reached historically extreme levels
    which in the past were associated with reversals.

  14. jm commented on Apr 19

    What you’re showing is a a result of what physical scientists refer to as a “hysteresis loop”.

    Generally, if you graph the internal magnetization of a material against the external applied field as you first increase the field until the material is as magnetized as you can make it in one direction (“saturated”), and then decrease the field to zero and increase it to saturation in that opposite direction, you’ll not get a single curve — the internal magnetization vs. external magnetization on the way down is not the same as on the way up, and your graph will show a loop — a “hysteresis loop”. (This is why a screwdriver remains magnetized after you apply a magnetic field and then take it away.) And if you plotted the external and internal magnetization both versus time instead of each other, you would see something like the stock market graph.

    Alas, much economic analysis assumes perfect reversibility — the absence of hysteresis.

  15. Will Rahal commented on Apr 19

    Are you referring to my charts?

  16. tyoung commented on Apr 19

    “Here’s one last chart via Zubin Jelveh of Portfolio. Note that Consumer spending, GDP and Employment all peaked long before the October 2007 market highs.”
    As ndallas points out that is an incorrect interpretation of those charts. It was the rate of growth that peaked prior to the stockmarket.

  17. Emmett commented on Apr 19

    This is off topic, but I’m noticing less doom and gloom in the TBP comments lately.

    Is the bearfest waning? Perhaps BR’s postings are directing his readership to more academic subject matter?

    Less schadenfreude certainly.

  18. Ross commented on Apr 19

    Hysteresis can also be a good thing. It keeps my thermostat within 3 degrees of where I set it…

  19. DaveM commented on Apr 19

    Let me start by saying I read this blog everyday because it does a good job at the immediate Big Picture. I think the question is too narrow….or at least needs to be re-framed somehow.

    I was schooled in marketing and found the general perspective narrow on behavior. Then I found (pro)traders had a much better perspective of the daily supply/demand/participation dynamics to understand ebbs and flows in markets.

    I suspect any market where people trade anything have important behavioral themes no matter how efficient they are. We read about speculation like this everyday in whatever business you are in but to get a solid bigger sense of it is hard. If you are willing to take a chance and step really far back and just look at it all as behavior, not of individuals but if groups in big chunked up periods of time act in coordinated ways…well by that time you are so far from financial markets it seems like ‘how could those long term perspectives have anything to do with fin. markets?’ If you are willing to do this you would do well to read (among other authors) one of Prechter’s books that doesn’t talk about scary crashes. The Elliott wave principle is a great tool till you use it to create big expectations. It offers an excellent perspective of humans in markets in general and then when you do begin to get back into the “math” of market participation (short term stuff) you can see that quant traders understand how we behave in groups, and how in groups, we can be seen to behave in recognizable patterns but also in ways that offer better-than-random probabilities to the future. If markets were truly efficient trading would have never become as large a profession as it has, right? Trends are how humans operate in groups. George Soros struggled to explain part of this lately. Just don’t expect that realization will be worth anything but a small edge on occasion to put on a trade. Dr. Brett Steenbarger has a really good perspective on the short term stuff. From the largest perspective, yes markets lead…but that and $2 gets you on the subway.

  20. Sri commented on Apr 19

    Good stuff….
    This is the reason I read this blog on regular basis. Excellent article & comments.

  21. BG commented on Apr 19

    Rich Shinnick wrote:

    “The market is female. Barry, neither you nor I are ever going to figure it out-but we just might get lucky from time to time.”

    Rick, you nailed it!! (I mean… you described it perfectly. Sorry. That was hilarious!!)

    Barry, it’s been a hellava week. Really enjoyed all that you put up on the blog. Keep it coming man.

  22. jake commented on Apr 19

    markets in the U.S. are rallying because short term interest rates are 1%..that’s when the last market started to rally in 2003…

  23. Bob A commented on Apr 19

    When has a bubble ever not burst?. So is a market going up in a bubble an indicator of better times ahead or of a certain bust ahead? It all depends on the time frame no?

  24. dblwyo commented on Apr 19

    Excellent post and in some ways better comments. Fruitful even where I don’t quite agree. Under Barry’s tutelage I’ve learned to think about markets having four major components: Structure, Fundamentals, Technicals and Sentiment. Each with a relevant timeframe. Over the very long-term structural factors determine economic growth and earnings, e.g Oil, Commodities and the supply-demand imbalances. Given a structure what determines l.t. market performance is earnings and valuations which is in turn based on profits and economic growth. Real earnings always revert to the l.t. growth rate and, when you look at the YOY% change charts, the markets tend to be codincident or lagging indicators. And have for decades (sorry Ross though that was a great post on systemic de-control). In the short-run technical factors dominate and in the very short-run emotional ones. Hence what I think is a bear-market sucker’s rally. I’d further argue that folks are seriously forgetting how early we are in this downturn and that earnings will lag. Oddly for an industry that’s supposed to be shot thru with analytic capabilities it doesn’t seem to do long-run modeling but instead extrapolates current situations into infinity and then adds Soros’ reflex in a feedback. Yikes !

  25. donna commented on Apr 19

    For a long while during the market peaks I saw markets as the store of inflation. Then the inflation moved into housing, now it is in commodities, driving up our food and energy prices.

    There is too much money out there, in the hands of too few, looking for too high a return. The markets are distorted by the game playing. The information they once contained is hidden under a layer of fat.

  26. SteveC commented on Apr 19

    Over the longer term, stock markets are a reasonable forward indicator of the economy. Over the short term, not so much. Much of the day to day or week to week action is driven by traders and fund managers looking for short term performance. Once a sector starts to move, the money will pile in for a while. If fundamentals don’t follow, the move falls apart.

    When you see a large long term move like the one they’ve had in Chinese market, pay attention. It portends quite a slowdown ahead, both there and probably here in US, at least in discretionary spending.

  27. Ross commented on Apr 19


    Loved your tight and cogent post and agree. As to the long term which I would define as 20 to 30 years, there seems to be some cycle at work which is difficult to define.
    I think of it as cycles within cycles within cycles. whenever I think of cycles I humm the song from Steve McQueens ‘Thomas Crown Affair’ ‘Windmills of your mind’.

    Each cycle seems to have different cause and effects but always seems to end the same. (insert Goethe poem)

    In the endless self repeating flows forever more the same

    Myriad arches straining, meeting, hold at rest the mighty frame

    Streams from all things, love of living, Grandest Star and humblest clod

    All the straining all the striving is eternal peace in God.

    I have a friend who is a geophysicist and spent his entire career specializing in resevoir management for Arco. He began on the north slope when oil was $10 a barrel. He ending in the late 1990’s when oil was $10 a barrel but now has a consulting business. It is rare for a person to enjoy what could be termed a two round trip career.

    This seems like the early 1970’s to me. That is where I came in. It’s like re-watching an old black and white movie but now in colour.

    Anyway a great post by Barry. Keep em coming, sonny…

  28. roger commented on Apr 19

    Hasn’t the Fed done everything it could do to start an equities bubble? That is the last bubble left. I think that when the market rallies on news of 19 billion dollar mark downs, or news of 5 billion dollar mark downs, that one has to ask: isn’t this the classic response predicted by moral hazard theory? If the too big to fail principle is being applied with a broad brush, and the Fed has taken on the job of administering interest cuts in spite of a context of spiraling commodity prices and a falling dollar, then the market is responding rationally. Or perhaps I should say mechanically. If you take a measuring instrument – say, a gauge for air pressure and rearrange its components – for instance, disconnecting its dial face from the springs that are suppose to transmit the force of the air to the needle of the dial – it will no longer measure as it did before. This is pretty much what the Fed has been doing. The volatility, the inexplicable swings upward.

    I don’t think equities will respond to the economic downturn for a while, because the Fed is doing all it can to prevent that response.

  29. Bthunder commented on Apr 19

    Explain this to me: The Bear market has bagun on May 10-11, 2006, not too long after consumer spending, employment and rate of GDP growth have all peaked (according to the graph above)
    All of the sudded, the Bear has been reversed in July, right after Henry Paulson became Sec. of the Treasury. What followed was 13 moths of gains, over 25% for main averages. As we can see from the charts, it wasn’t based on neither of GDP growth, consumer spending, or employment. In retrospect, we now know that the July 2006-August 2007 Bull market was fueled by UNPRECEDENTED leverage buyouts and stock buybacks financed through debt. It had nothing to do with the economic fundamentals! Does anyone remembers Merrill Lynch buying back own shares at the very top? Around $100 per share? I guess thousends of laid off Merrill rank-and-file wish that Merrill had that cash now. But not to worry, someone was selling to them. People who run Blackstone knew when to cash out…. John Thain isn’t crying – $80mil check for what? 3 weeks of service? I’m sure thare are many top execs at Merrill that sold their shares back to the firm at $100, and they’re not crying.

    The indicators were right, the element that was different this time around is that SOMEONE took the market and most of its participants for a ride! And now, with 20%+ M3 growth, they’re making everyone pay for their “play.” Dow Jones index near 13000? That’s in today’s dollars. In 2003 dollars, it would be more like 8000!

  30. Winston Munn commented on Apr 19

    Many of the market concepts originated in a different era, under different circumstances – the market as a future discounting mechanism, for example, was believed back in the days when dividends were king and an increase in dividends was associated with a rise in stock price.

    The modern market with emphasis on stock price as the return mechanism resembles more the commodities exchanges with shorter return periods are anticipated.

    All that is being discounted is the lengths of the anticipated trades, which makes the market unreliable as an economic indicator.

  31. Bob Abouey commented on Apr 19

    Excellent post. Reminded me of Soros’ concept of reflexivity as an essential counterpoint to the concept of market efficiency.

    And, not surprising when I did a quick google search for a summary of the theory to refresh my own memory (“Soros reflexivity”), the third link is to the big picture, which reprinted a full speech on the subject back in 2004… As they say, great minds… ;-)

    So rather than paraphrase, here’s that link:


  32. Bob Abouey commented on Apr 19

    Sorry, can’t resist at least posting one quote from the Soros speech I just linked to that relates directly to the current discussion:

    “I must state at the outset that I am in fundamental disagreement with the prevailing wisdom. The generally accepted theory is that financial markets tend towards equilibrium, and on the whole, discount the future correctly. I operate using a different theory, according to which financial markets cannot possibly discount the future correctly because they do not merely discount the future; they help to shape it. In certain circumstances, financial markets can affect the so called fundamentals which they are supposed to reflect. When that happens, markets enter into a state of dynamic disequilibrium and behave quite differently from what would be considered normal by the theory of efficient markets. Such boom/bust sequences do not arise very often, but when they do, they can be very disruptive, exactly because they affect the fundamentals of the economy.”

  33. kio commented on Apr 19

    I would describe the market using two components – varying deterministic (driven by real economic growth) trend and fluctuations related to misinterpretations of the evolution of the real economy. People react with some delay and usually overreact extrapolating the trend linearly in the future.
    Second component can and will be suppressed when more robust description of the real economic growth will find its way to the minds of the market players.

    These fluctuations obviously lag behind the deterministic trend. The trend is varying over time. Depending on periods of these changes in real economic growth, the fluctuations might seemingly lead some later changes in real economic growth. This may result in an erroneous conclusion of some actual lead.

  34. jm commented on Apr 19

    Will Rahal,

    I was referring to the last chart of Barry’s post. I started writing before you posted your comment, and so was unaware of it.

  35. dblwyo commented on Apr 19

    Ross, Bob Ab.,Kio: think we’re converging on the same model. Ross’s Windmills metaphor will stay with me for a while though I’m too young to recall the movie of course :). I took a look at l.t. market returns here:
    in case you’re interested. Results are a bit surprising. Not published but to Ross’ key points went back and looked at innovation cycles which moved Coal/Steel (1870s-1890s) to Gas/Chemicals/Electricity (1900s-1920s) to Pharma/Electronics/Plastics (1950s-1990s) with a lot of looseness and you can see the multi-decade introduction, innovation, surge, maturities leading to those long secular cycles. Which would be the deterministic part. Then the shorter-term non-deterministic with the fantasy feedback loops that Soros talks about. Right now our secular re-structuring is not about our own Next Big Thing about the re-structuring of the world economy back to the balance it had in the 1820s when China and India were the world leaders.

  36. Groty commented on Apr 19

    Here’s my theory.

    Equities have a long-term upward bias and the normal state of the economy is to be in growth mode. Recessions are rare. So asset managers don’t want to sell “too soon”, even when they think a recession is more likely than not, because if they are wrong and a recession does not materialize, they will likely underperform their benchmark. The risk of underperforming creates an incentive to stay invested. That’s why I think equity prices do a lousy job anticipating recessions.

    On the other hand, after equity prices have corrected to account for the recession, and knowing the long term bias is for higher prices, managers are eager to buy stocks at discounted prices. So they start coming back into equities long before the fundamentals have turned. If they wait too long, then once again they will surely underperform their benchmark. So equities do a great job of anticipating recoveries.

    So in my opinion, the reason equities do a poor job of anticipating recessions but do good job of anticipating recoveries boils down to how asset managers are measured/compensated and the long term upward bias in prices.

  37. eightnine2718281828mu5 commented on Apr 19

    I think they lead, but they lead more aggressively for good news (6-9 months) and only barely lead for bad news (1-2 months).

    Bulls hate missing bonuses and are willing to risk OPM to make it happen, so good news is trumpeted for months in advance while bad news is ignored until the ambulance crashes through their patio windows.

  38. DL commented on Apr 19

    It’s largely a question of “dumb money” versus “smart money”. The smart money gets in early, and properly anticipates the fundamentals of the future; the dumb money then gets in, thinking the current trend (whether up or down) is going to go on forever. And the REALLY smart money takes a short position at the top, selling the asset to some poor sap who gets burned in the end.

  39. Ivo commented on Apr 19

    Agree with Groty, DL and eightnine2718281828mu5.

    My observation is that equity markets are as good an indicator for recessions as consumer confidence is (both are late to the “party”) – one can use the charts interchangeably.

  40. Ivo commented on Apr 19

    And actually the lead of equities is behind that of the bond market. At least on a downturn.

  41. lurker commented on Apr 20

    Short covering is NOT a new bull market.

  42. Juan commented on Apr 20

    When, if at all, did SP500 earnings peak during the late 1990s? Broader, more economic NIPA measure of corp. profits peaked 3Q97, or about what would have been expected given the somewhat earlier profit slump in Asia, a slump which preceeded the financial crisis.

    Share prices now seem to lag changes in economic profit, likely a consequence of what has become an overcapitalized system.

  43. Larry commented on Apr 21

    I wouldn’t trust the Chinese economic data and indicators as far as I can throw the Great Wall.

    The signs all pointed to a huge bubble anyway. Every other ayi seemed to be day trading.

  44. Juan commented on Apr 21

    Larry, if the China reference had to do with my post, I’ll try to be more clear. The ‘Asian Crisis’ has been portrayed as currency crisis, hot money crisis, etc. but those doing so almost never take account of change in rate and mass of economic profit in, for example S Korea and Thailand well before the overt phase and its devaluations. That is, the most dynamic region of the world economy had begun evidencing weakness in advance of the market drops — same thing here in the U.S. but began slightly later and even as the indices continued to power higher and higher.

    Not good for timing but was helpful as a ‘caution light’.

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