What is the relation between economic activity and the stock market over the business cycle? This blog post presents some of the conclusions from my book From Main Street to Wall Street. One conclusion is that the business cycle has a strong impact on the stock market, another that post-1945 business-cycle dynamics are very different from pre-1945 business-cycle dynamics.
In this third part of my small four-part series of blog posts presenting glimpses of my book From Main Street to Wall Street, I turn to its examination of the relation between the stock market and the economy over the business cycle. It follows my first post (link), where I explained why I wrote the book, and the second (link), where I presented some of the book’s conclusions with respect to the long-run relation between the stock market and the economy.
The business cycle
In this part of the book, I explain what the business cycle is, what characterizes it, what causes business-cycle fluctuations in economic activity, and economic theories that explain business cycles.
Today, May 4, 2021, the Council for Return Expectations publishes its updated forecasts. We still expect very low – negative – returns on safe assets, though not as negative as we expected six months ago. We also expect marginally lower returns on risky assets. Compared to six months ago, we thus expect a lower equity risk premium.
I chair the Council for Return Expectations (link). Danish banks and pension companies use our forecasts when they project how their customers’ savings will develop. In this blog post from July last year (link), I describe the history of the council, who we are, why we publish expected returns, what they are used for, and so on.
Twice a year, we update our expectations. Today, we publish our latest forecasts.
My book – From Main Street to Wall Street (link) – has been published. This blog post explains why I wrote the book and its contents. The next three posts (that will be sent out in due course) will present some of the analyses and conclusions from the book.
start in 2008. The financial crisis was at its worst.
I was a young professor of finance. I studied financial crises (my Ph.D. is on currency crises) and the relation between the macroeconomy and expected stock returns.
During the last couple of weeks, yields have been rising and stock markets falling. Standard market turbulence is not interesting for this blog – stocks go up and down, most of the time up, and yields fluctuate – but intriguing (and expected) patterns characterize recent events.
Everybody seems to agree what is going on markets these weeks: Vaccines
are successful and being rolled out, so economies will open up soon, and Biden
will get his stimulus package to the tune of USD1.9tn. These two things (an
already strong economy when opening up and on top of that a large stimulus
package) will lead to very strong growth during the second half of 2021.
Inflation will rise and the Fed will have to tighten monetary policy. The
expected rise in inflation and the policy rate leads to increases in yields
today. This hurts stocks. These US developments spill over to other countries.
This story largely makes sense. Looking at the data, however, interesting outstanding issues remain.