Statistical correlation analysis between the US GDP and S&P 500 Index

The Correlation Between Financial Markets and the US Economy: Insights from a 10-Year Rolling Correlation Analysis

The relationship between the financial markets and the economy has long been a subject of debate among analysts and investors. While some argue that the stock market is a leading indicator of economic growth, others contend that it is driven more by expectations and sentiment. In this article, we examine the correlation between the S&P 500 index and the US economy over the past 74 years (1948-2022) using a 10-year rolling correlation analysis.

We used data from the Federal Reserve Economic Data (FRED) to calculate the correlation coefficient between the S&P 500 index and real US GDP from 1948 to 2022. We then performed a 10-year rolling analysis to identify any trends in the correlation over time. Additionally, we lagged the S&P 500 index data by 3, 6, 9, and 12 months to examine whether there is any lagged relationship between the two parameters.

Figure 1: S&P 500 and Real US GDP, quarterly percent change (YoY)

Our analysis found that there was no significant correlation between the S&P 500 index and real US GDP over the entire 74-year period. The 10-year rolling correlation remained relatively stable at around 30% on average. This supports the view that the stock market is more driven by expectations and sentiment than by economic fundamentals.

However, when we lagged behind the S&P 500 index data by 6 months, we observed a significant increase in the correlation between the two parameters. The correlation coefficient rose from 30% to almost 60%, suggesting that S&P 500 index change lagged by 6 months could potentially give us a direction for the markets today.

Figure 2: Rolling 10-year correlations between S&P500 (Lagged) and Real US GDP, quarterly percent change (YoY)

These findings have important implications for investors and analysts who are looking to predict market trends based on economic data. While the lack of correlation between the S&P 500 index and real US GDP over the entire period analyzed supports the view that the stock market is driven more by expectations and sentiment, the significant increase in correlation when S&P 500 is lagged by 6 months suggests that economic data can still be a useful tool in predicting market trends.

In conclusion, our analysis provides new insights into the relationship between financial markets and the US economy. While the lack of correlation between the two parameters over the long term supports the view that the stock market is more driven by expectations and sentiment, our findings suggest that economic data can still be a useful tool in predicting market trends, particularly when lagged by a few months. This is good news for investors and analysts who can predict GDP by using leading economic indicators.