Does the Economic Surprise Index predict a stock market correction?


A lot of people have been talking about the recent “slowdown in U.S. economic data”.

  1. Our fund focuses in the REAL economic data. “Is the data actually going up or down?”
  2. The bearish investors are focusing on the data vs. expectations.

These 2 things can diverge from time to time.
Ultimately, it’s the “real data going up or down” that determines bull and bear markets. In the long term, economic analysts’ expectations do not matter. Only facts matter.
However, the pessimists argue that the slowdown in “data vs expectations” will cause a small or big correction. Are they right? What does history say? Let’s compare the Citigroup Economic Surprise Index to the S&P 500’s historical corrections.

Where we stand now

The Citigroup Economic Surprise Index stands at -33.6 as of May 18, 2017. This means that U.S. economic data has on balance been missing expectations more than it has been beating expectations.

What happens historically when the Citigroup Economic Surprise Index falls below -30?

Let’s find all the historical cases. Were these historical cases followed by U.S. stock market corrections? If so, how big were the corrections?
*We are only looking at the bull market cases. We ignore the bear market cases.

  1. 5/03/2004
  2. 6/08/2004
  3. 4/02/2005
  4. 3/02/2006
  5. 18/09/2006
  6. 29/06/2010
  7. 6/05/2011
  8. 29/05/2012
  9. 7/06/2013
  10. 7/03/2014
  11. 12/02/2015
  12. 21/12/2015
  13. 29/04/2016

Let’s look at each of these cases individually

March 5, 2004
This EXACTLY caught the top before the S&P made a small 8.6% correction from March – August 2004.
August 6, 2004
The Citigroup Economic Surprise Index deteriorated again by early August. However, this was the exact bottom of the prior correction! Anyone who sold stocks here would have been clobbered by the next small rally.
February 4, 2005
This was pretty close to the top in terms of time and magnitude. 1 month later, the S&P made a small 7.5% correction.
February 3, 2006
The Economic Surprise Index failed to predict a small correction this time. The S&P continued to rally before making a small correction from May – June 2006. However, the good news for bears is that the S&P eventually fell below its price in February 2006.
September 18, 2006
The S&P soared for 5 months after the Index deteriorated below -30. The subsequent small correction did not even fall back to the S&P’s level on September 18!
June 29, 2010
After a significant correction beginning in late-April 2010 (which our model predicted), the Economic Surprise Index deteriorated at the bottom of the significant correction. Anyone who sold stocks here would have been clobbered by the subsequent rally.
May 6, 2011
This was perfect timing. The Index deteriorated just when the S&P was beginning its significant correction that lasted from May – October 2011.
May 29, 2012
The Index deteriorated a few days before the S&P bottomed. Before this signal came out, the S&P was almost finished its 10.9% correction that began in April 2012.
June 7, 2013
This signal came out when the S&P 500 had halfway completed its small 7.5% correction.
March 7, 2014
The U.S. stock market rallied more than 6 months after this signal came out. Then the next small correction brought the S&P down to its March 2014 level.
February 12, 2015
This signal came out 3 months before the S&P began its significant correction, which lasted from May 2015 to February 2016.
December 12, 2016
Half a month after this signal came out, the S&P cratered around 13%.
April 29, 2016
The S&P made a marginal new high 1.5 months later and then made a small 6% correction.

Conclusion

Sometimes this signal came out AFTER the S&P 500 fell more than 6%, which is the magnitude definition of a correction. Excluding those cases….
The S&P always AT LEAST fell below the price when this bearish signal came out. There was only one exception (September 18, 2006).
It’s clear that this indicator is not very useful for timing corrections. It can’t predict whether the correction will be a small one or a significant one either.
Since the S&P has not fallen more than 6% yet, this means that the Citigroup Economic Surprise Index (-32) is predicting a small correction right now. This fits in line with our view that the S&P 500 will make a small correction very soon.

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