Bottomline: A slowing US economy isn’t good for equities

After the dip in US GDP last week, the other important data release that has a significant bearing on how the US Federal Reserve moves on rates is the Personal Consumption Expenditure Index (PCE). Fed Chair Jerome Powell recently told reporters that the central bank considers PCE a better gauge of inflation than the Consumer Price Index (CPI). The latest reading of the PCE of 6.8 percent, the highest 12-month gain in 40 years, and a several-decade high 1 percent gain month-on-month is thus not comforting.

But what’s also concerning, is that a slowing US economy and the energy crisis in Europe aren’t the most favourable backdrop to have if you are expecting the market to rally. In order to get a better sense of how significantly several commonly cited factors driving the markets truly influence moves, we ran some numbers. Here’s what we have.

PCE doesn’t drive stocks

Does a high PCE really lead to a big impact on equities? No. Quite to the contrary, monthly data since 2000 reveals that the correlation between the PCE and the S&P-500 index is just about 0.07 percent. That’s as good as nothing.

US GDP and equities tango 

What should worry bulls is that US GDP and the S&P-500 index have a strong correlation of 0.85. So, if the US economy is heading for a long patch of de-growth or anaemic growth, going by empirical evidence, stocks may find it difficult to maintain an upward trajectory.

Hence the recent two negative prints on US GDP growth, that have cheered the markets in the short-term (on the hope that it would stay or temper the Fed’s hand on further rate hikes), may become a worry down the line. Add to this the European economies under stress over energy supplies, and we could have a not so promising cocktail of surprises down the road.

US bond yields may matter

The widely tracked US 10-year bond yield is a parameter that may have some relevance in an inverse way with equities. The benchmark yield and S&P-500 index have a moderate negative correlation of 0.65. So, if yields rise, there’s a good chance the S&P-500 might sulk, and similarly the other way around. In the recent equity run-up, we have seen that the US 10-year yield has cooled off significantly from over 3 percent.

Stocks don’t chime to USD 

The US $ index is a widely tracked number, and relevant in many ways for the economy, but it has little or no bearing on market swings in the US. The US $ index and S&P-500 have a correlation reading of just 0.17.

Takeaways for Indian equities 

So, what does all this spell for Indian equities. We all know that US equities and Indian benchmark indices are closely correlated. So, if the US economy wobbles for a long period, equities too may follow a similar trend. This does not necessarily mean the magnitude of change would be similar, i.e, Indian equities could underperform or outperform but the direction is likely to be similar.

Will history repeat itself? That remains the big question. The answer to which will unfold in time.

Happy investing.

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