The Historical Relationship Between the Economy and the S&P 500, Part 1

by Mike Kimel

The Historical Relationship Between the Economy and the S&P 500, Part 1

This post is the first in a series on the historical relationship between the economy and the stock market. Data used in this post is the adjusted close of the S&P 500 going back to 1950 and quarterly nominal GDP going back to the same date. Because quarterly GDP figures measure the economy at the midpoint of the quarter, the S&P 500 for February, May, August and November are considered the analogous “quarterly” S&P 500 figures.

The following graph shows how the two series have evolved since 1950.

Figure 1

A simple eyeball test does indicate that historically, the two series have mostly moved together. And in fact, the correlation between the two series has been 93.5%, which is extremely high.

But which series has led and which has followed? For that, we look at the next graph:

Figure 2.

The black line shows the correlation between GDP and the S&P 500 x quarters hence, where x = 0, 1, … 24. In other words, it shows the correlation between GDP and the S&P 500 in the same period, the correlation between GDP and the S&P 500 lagged by a quarter, the correlation between GDP and the S&P 500 lagged two quarters, etc. As the black line shows, historically, GDP seems to have led the S&P 500 by about 16 quarters, or about four years; the correlation between GDP and the S&P 500 16 quarters out is about 94.1%. One possible reason… historically, when the economy grew, it encouraged more investment in corporations, but in many instances, investments take a long time (four years) to show up in ways that boost the market.

The red line looks at the relationship the other way – it looks at the correlation between the two series with the S&P 500 leading GDP. It shows that the correlation between the S&P 500 and the lagged GDP reached a peak of 95.2% when GDP was lagged by 10 quarters, or about two years. One possible explanation… historically, a growing stock market has made people feel wealthier, which in turn caused them to buy more stuff.

The conclusion from this… going back to 1950, GDP has led the S&P 500 and vice versa.

In the next post in this series, I’ll take a look at how this relationship has changed over time.
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A few notes…
1. I’m not a financial advisor. I strongly suggest against making investments based on anything written above.
2. If you want my spreadsheet, drop me a line via e-mail with the name of this post. My e-mail address is my first name (mike), my last name (kimel – with one m only), and I’m at gmail.com.

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