Macroeconomic Factors - Evidence from USA

Macroeconomic Factors and Stock Returns: Evidence from USA
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Macroeconomic Factors and Stock Returns: Evidence from USA
Abstract
Correlation between share prices of different firms and macroeconomic variables spur a lot of attention and debate amongst economists and financial scholars. Contemporary, there is increasing integration of financial markets and implementation of reforms connected with stock markets. Amazingly, many scholars assume that there is great significance within the various activities that occur within stock exchange markets. Stock market forecasting and prediction has basis on information obtained from the stock exchange markets. In order to attain such forecasts and predictions, economists considered significantly the macroeconomic variables. Even though there are numerous studies on the same topic, market dynamisms and turbulences call for more studies. Consequently, this is a continuation of previously conducted study. In this study, researcher attempts to establish correlation between index returns and specific macroeconomic variable namely exchange rates, Gross Domestic Product (GDP), unemployment, Treasury bill rates, and West Texas Intermediate (WTI) with evidence Taiwan. The main purpose of this study is to establish in details and finely correlation between stock prices and the mentioned macroeconomic variables. This follows empirical studies earlier on identifying such relationships.
Introduction
Essentially, efficient capital markets experience significant fluctuations of security or stock prices with inflow of information. Just like perfectly competitive markets, capital markets have full information as most of the stocks or shares exchanged are advertised openly, not only via media but also within the stock market (Flannery & Protopapadakis, 2004). In any case, efficient capital market hypothesis states that stock prices of publicly traded organizations must have relevant information, which is also publicly available information. Policy makers and stockbrokers need such information in order to make proper and informed decisions regarding investments into publicly traded firms. From this perspective, there are no restrictions for such individuals to carry out national macroeconomic policies without any intentions of influencing capital market structures and operations. In view of economic theories, expectations on future corporate performance rely significantly on stock prices. In addition, levels of economic activities within a given nation are congruent to corporate profits of firms in the same region. Following this argument, stock prices are a true representation of the underlying economic fundamentals hence indicators of economic activities.
The following is a study report on correlation between stock prices and macroeconomic variables that include exchange rates, Gross Domestic Product (GDP), unemployment, Treasury bill rates, and West Texas Intermediate (WTI) with evidence USA. This report is statistical in nature; it employs both descriptive and inferential statistics (Flannery & Protopapadakis, 2004). Descriptive statistics include measures of central tendency and dispersion that help in interpreting the relationship between stock prices and macroeconomic variables (Humpe & Macmillan, 2007). Inferential statistics on the other hand employs correlation and regression analysis in order to test the hypothesis thus assisting in making of a conclusive and decisive conclusion regarding the subject. A brief discussion of the various variables coupled with literature review also form part of the paper.
Understanding the Variables
Unemployment Rate
Unemployment rate is the percentage of the labor force that is not in any formal employment but have attained the age and acquired the skills required for such jobs. The unemployment rate is one of the economic indicators that economists examine to help understand the state of the economy concerning meeting macroeconomic principle of full employment (DeStefano, 2004). While employment rate shows a country`s ability to put its population to work and thereby generate income for its citizens, the unemployment rate provides an indication of inability of a nation to develop productivity of its population (Flannery & Protopapadakis, 2004). Consequently, countries with higher unemployment rates are likely to have poor or low standards of living as opposed to those countries that have high employment rate or low unemployment rate.
Exchange Rates
The charge for exchanging currency of one country for currency of another is the exchange rate. Exchange rate movements frequently focus on changes in credit market conditions, reflected by changes in interest rate differentials across countries, and changes in the monetary policies of central banks (Flannery & Protopapadakis, 2004). The profit-maximizing investors in an efficient market will ensure that all the relevant information currently known about changes in macroeconomic variables are fully reflected in current stock prices, so that investors will not be able to earn abnormal profit through prediction of the future stock market movements. The conclusions drawn from the efficient market hypothesis (EMH) includes early studies Adam (2008) affirmed that macroeconomic variables influence stock returns.
West Texas Intermediate
West Texas Intermediate, also known as Texas light sweet, WTI is a grade of crude oil that forms the basis of pricing oil within the USA. WTI is a macroeconomic variable since it affects major sectors of the economy. In the process of pricing the oil, WTI is the basis hence affects various components of the economy including the stock prices. With increasing oil prices, many other economic variables are affected significantly. This makes WTI a significant variable in attempting to define correlation between the same and stock prices in the stock exchange.
Treasury bill rates
Treasury bill rates affect the rate of investment through influencing the amount of money in circulation. In any case, most economies use Treasury bill rates to regulate the supply of money hence monetary policy. From this perspective, there are no restrictions for such individuals to carry out national macroeconomic policies without any intentions of influencing capital market structures and operations. Since the Treasury bill controls the amount of money in circulation by persuading commercial banks either to purchase from the central bank or rather sell their deposits the amount of money for investment purposes will be limited hence affecting stock prices either negatively or positively.
Methodology
The study was empirical in nature. The data for macroeconomic variables was collected secondary data. The analysis is based on stock portfolios rather than single stocks. In portfolio construction, four criteria are used: Market capitalization, price/earnings ratio (P/E ratio), PBR and yield. First, all the companies listed in Taiwan Stock Index were grouped into big, medium, and small companies based on market capitalization. Then in each big, medium, and small company, three sub-portfolios were made based on P/E ratio, yield and PBR. In all for big, medium, and small companies, there were nine portfolios. The macro economic variables used in the study are employment rate, exchange rate, GDP, WTI and Treasury Bill Rates. Annual portfolio returns were calculated for each year of study. Normality of data was checked through Kolmogorov-Smirnov D statistic normality test in SPSS16. Regression was applied to calculate the impact of macroeconomic variables on stock returns.
Data Analysis and Presentation
The following table provides data applicable in establishing correlation between share prices and the mentioned macroeconomic variables. Macroeconomic variables in this case are independent vari...