Int Adv Econ Res (2024) 30:255–278

https://doi.org/10.1007/s11294-024-09901-5

Stock Markets Cycles and Macroeconomic Dynamics

Puneet Vatsa1 · Hem C. Basnet2 · Franklin G. Mixon Jr.3 ·

Kamal P. Upadhyaya4

Accepted: 10 June 2024 / Published online: 11 July 2024

© The Author(s) 2024

Abstract There is a consensus that stock markets are procyclical. However,

answers to some important questions remain unclear. Do stock markets lead or lag
business cycles? More interestingly, what is the duration with which they lead or
lag them? This study uses different time-series filters and time-difference analysis to
answer these questions by examining the dynamic interactions between three major
stock indices and key macroeconomic indicators in the United States. The findings
show that stock markets have been strongly procyclical, lagging industrial produc-
tion by one to three months in recent decades. There have been noteworthy changes
in the relationship between inflation and stock market cycles. The correlations
changed from negative in the 1980s and 1990s to positive in the 2000s and 2010s.
The results also reveal close associations between the stock indices, offering new
insights into the interplay between financial markets and economic cycles.

Keywords Hamilton filter · Time-difference analysis · Stock market indices ·

Industrial production · Employment · Inflation · U.S. economy

JEL Codes C22 · C58 · E20 · E30 · E60 · G10

* Hem C. Basnet
[email protected]
1
Faculty of Agribusiness and Commerce and Centre of Excellence in Transformative
Agribusiness, Lincoln University, Lincoln, Canterbury, New Zealand
2
Department of Financial Economics, Methodist University, 5400 Ramsey St., Fayetteville,
NC 28311, USA
3
Center for Economic Education, Columbus State University, 4225 University Avenue,
Columbus, GA 31907, USA
4
Department of Economics and Business Analytics, University of New Haven, 300 Boston Post
Road, West Haven, CT 06516, USA

13
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256 Vatsa P. et al.

Introduction

A rational stock market utilizes all available information to forecast real economic
activity. If it does well, expectations for future economic conditions are incorporated
into current stock prices, and investors may see stock market performance as a pre-
dictor of real economic activity (Fischer & Merton, 1984). Stock markets also react
to changes in future economic prospects. These reactions can lead to market fluctua-
tions and even crashes. Thus, understanding the interactions between the economy
and stock markets is crucial. Economic fundamentals directly affect stock perfor-
mance, and stock indices can signal upcoming economic shifts (Schwert, 1990).
For example, rising output increases investment returns, which in turn stimulates
capital spending. An efficient market anticipates this and rallies ahead of real eco-
nomic changes. Conversely, a bleak economic outlook may lead to downward revi-
sions of future profits. Firms might then pause investing while awaiting clarity. This
can reduce capital spending and output. Here, stock market declines precede drops
in real economic activity.
Financial investors consider industrial production as a key business cycle indica-
tor. The promise of economic growth increases expected business profits, leading to
higher stock prices. In contrast, economic slowdowns can lead to asset liquidation
and falling stock prices. Changes in employment are also correlated with stock mar-
ket returns, reflecting broader economic trends. Growing employment suggests eco-
nomic expansion and higher future profits. However, economic expansion ultimately
puts upward pressure on wages, which can reduce a firm’s profitability. Although
economic expansions can increase stock prices, reduced profitability may cause
them to fall.
The interconnections between stock markets and the macroeconomy have been
studied extensively. However, key questions persist around whether stock markets
lead or lag business cycles. More interestingly, by how much time does one lead or
lag the other? Simply stating that stock markets precede business cycles provides
little practical insight. More useful conclusions would measure exactly the length
of time with which stock market cycles lead or lag business cycles. Moreover, dif-
ferent stock indices may lead the business cycle with different durations. Providing
insights into the lengths of these durations is one of the primary contributions of this
paper.
The relationship between inflation and the stock market is ambiguous (Wang &
Li, 2020). During periods of economic growth, increased profitability often leads
to bullish stock markets, coinciding with inflation driven by robust economic activ-
ity. Contrastingly, in times of economic stress, such as during high oil prices in the
1970s, expectations of higher inflation and lower economic output can lead inves-
tors to anticipate decreased profitability and stock sell-offs, aligning inflation with
bearish markets. The influence of tax codes on business profits also plays a role.
Inflation diminishes the real value of tax deductions on depreciation, increasing real
tax liabilities and reducing after-tax profits, potentially leading to lower stock prices
(DeFina, 1991; Feldstein, 1980; Quayes & Jamal, 2008).

13
Stock Market Cycles & Macro Dynamics 257

This points to the intricacies of the associations between the stock market and the
macroeconomy. This study is devoted to analyzing these associations for the United
States (U.S.) stock market and the macroeconomy. Specifically, the Hamilton filter
(Hamilton, 2018) is employed to extract the cyclical components from three stock
indices, the Standard & Poor’s 500 (S&P 500), the Dow Jones Industrial Average
(Dow), and the Nasdaq Composite (Nasdaq) and three key macroeconomic varia-
bles, the Industrial Production Index (IPI), total non-farm employment (NFE), and
the Consumer Price Index (CPI). Prior studies mainly relied on the Hodrick-Prescott
filter to derive cyclical components from observed series. However, Hamilton (2018)
argued that the Hodrick-Prescott filter can generate spurious cycles that are discon-
nected from the underlying data-generating processes. Schüler (2018a) showed that
the Hodrick-Prescott field yields spurious cycles. Hamilton’s method is based on a
few past observations and overcomes several shortcomings of the Hodrick-Prescott
filter. The current study is the first to combine this approach with time-difference
analysis (Fiorito & Kollintzas, 1994; Serletis & Kemp, 1998) to examine the lead-
lag relationships between stock indices and macroeconomic variables and provide
specific answers about the lengths of time characterizing these relationships.
The findings indicate a strong, positive correlation between U.S. stock indices
and the business cycle between 1990 and 2020, with stock markets typically lagging
industrial production by one to three months. The analysis also reveals that the asso-
ciations between the U.S. stock market indices and inflation have changed notice-
ably over time. In the 1980s and 1990s, they were negatively correlated, whereas,
during the 2000s and 2010s, they were strongly and positively correlated. There is
evidence, albeit less compelling, of a negative association between the real economy
and stock market cycles during the 1980s. Unsurprisingly, the three stock indices
have exhibited strong co-movement throughout the last 40 years.

Prior Literature: A Brief Review

Early studies indicated that specific macroeconomic indicators drive financial mar-
ket sentiments. For example, Ross (1976) argued that changes in certain macroe-
conomic variables cause changes in systematic risk factors and, thus, affect stock
returns. Shiller (1980) suggested that stock prices are dependent on future expected
cash flows and future discount rates. He emphasized the importance of economic
factors in shaping both the expected earnings potential of companies and investor
appetite for taking on risk. Schwert (1990) attributed the huge surge in stock returns
in the U.S. from 1889 to 1988 to industrial production growth.
More recent studies also showed that macroeconomic variables are good candi-
dates for predicting stock market returns. Rapach et al. (2005) reported that mac-
roeconomic variables are effective predictors of stock market returns. Chen (2009)
concluded that the real macroeconomy affects the stock market through investment
opportunities and consumption, with stock returns responding to policies affecting
savings, investments, and the money supply. Relatedly, Liu and Shrestha (2008) and
Peiro (2016) found that macroeconomic variables, such as industrial production and
long-term interest rates, explain movements in stock prices.

13
258 Vatsa P. et al.

Chen and Chiang (2016) reported a causal relationship between the macroecon-
omy and the stock market. Borjigin et al. (2018), who examined causality between
the macroeconomy and the stock market in China, found evidence for a strong, non-
linear, bi-directional causality. A more recent study by Wang and Li (2020), using
Chinese monthly data from 1995 to 2018, indicated that stock returns were related
to industrial production growth (a proxy for output growth), inflation, and interest
rates.1 Based on their overall findings, however, Wang and Li (2020) concluded that
stock market indices could not be used as leading indicators of the macroeconomy
and that the real macroeconomy cannot predict booms or busts in the stock market.
In this regard, the conclusions of Wang and Li (2020) support those of earlier stud-
ies by Kwon and Shin (1999) and Gan et al. (2006), which suggested that although
stock indices are cointegrated with major macroeconomic variables, they are not
leading indicators of real macroeconomic performance.2
Studies by Si et al. (2019) and Kim and In (2003) used wavelet analysis to exam-
ine the associations between financial markets and the real economy. Si et al. (2019)
found that stock market cycles led business cycles in the short run, whereas the
reverse was true over the long run. They also found that stock market cycles behaved
differently during expansionary and recessionary phases of the business cycles. Kim
and In (2003) also concluded that the association between the stock market and the
macroeconomy changed over time.
However, the relationship between inflation and stock prices proved more
nuanced. While some studies identified a positive association between inflation and
stock prices (Abdullah & Hayworth, 1993; Camilleri et al., 2019; Ratanapakorn &
Sharma, 2007), others pointed to a negative association (Quayes & Jamal, 2008).3
Given the mixed evidence on whether stock markets lead or lag the macroecon-
omy, it is unsurprising that this issue continues to be debated. The present study
contributes to this debate.

Methodological Framework and Data

Methodological Framework

This study utilized a recently developed method proposed by Hamilton (2018) to

extract the cyclical components from non-stationary time series by estimating an
autoregressive model using ordinary least squares. Hamilton’s method is straightfor-
ward to implement and uses only a few observations, the number of which depends
upon the frequency of the data. Critical to this method is the characterization of the
trend. Usually, a trend is defined over an infinite horizon. However, Hamilton (2018)

1
These studies are not entirely conclusive, given the absence of causality found in the work by Gallegati
(2008) and Girardin and Joyeux (2013).
2
This work only suggests that stock markets and the macroeconomy share a common long-run trend.
3
DeFina (1991) noted that in the 1970s, when inflation accelerated, stock prices fell almost 50% in real
terms. Equity values increased markedly in the 1980s, a period of disinflation in the U.S.

13
Stock Market Cycles & Macro Dynamics 259

suggested using a two-year horizon, arguing that it is both practical and useful. For
a two-year horizon, it is possible and meaningful to make informed conjectures
and form reasonable expectations based on limited sample sizes. Hamilton (2018)
pointed out that irregular and unforeseeable cyclical developments are the primary
reasons for incorrectly predicting the value of a series two years in advance.
Cyclical components are often derived as deviations of the actual series from
its trend component. For example, Beveridge and Nelson (1981) and Hodrick and
Prescott (1997) defined the cyclical component ct at time t as yt – gt, where yt is the
observed series, and gt is the derived long-run trend of yt.4 According to Hamilton
(2018), the cyclical component at time (t + h) is well-approximated by yt + h – ­yt. In
other words, the cyclical component at time t is simply yt – ­yt – h. He proposed a fore-
cast for yt + h that relies on the recent p values, where both h and p are integer mul-
tiples of the number of periods in a year. Accordingly, in the case of monthly data,
h and p are represented by 24 and 12, respectively. This forecast can be formally
described as
yt+24 = 𝛼0 + 𝛼1 yt + 𝛼2 yt−1 + 𝛼3 yt−2 + ⋯ + 𝛼12 yt−11 + vt+24 . (1)
Put differently,

(2)
( )
v̂ t+24 = yt+24 − 𝛼̂ 0 + 𝛼̂ 1 yt + 𝛼̂ 2 yt−1 + 𝛼̂ 3 yt−2 + ⋯ + 𝛼̂ 12 yt−11 .

The time subscripts in Eq. (1) and Eq. (2) can be adjusted to represent the origi-
nal time series and the residuals, respectively, at time t. While Eq. (1) can be rewrit-
ten as
yt = 𝛼0 + 𝛼1 yt−24 + 𝛼1 yt−25 + 𝛼2 yt−26 + ⋯ + 𝛼12 yt−35 + vt , (3)
Equation (2) can be rewritten as

(4)
( )
v̂ t = yt − 𝛼̂ 0 + 𝛼̂ 1 yt−24 + 𝛼̂ 2 yt−25 + 𝛼̂ 3 yt−26 + ⋯ + 𝛼̂ 12 yt−35 .

Equation (4) yields the cyclical component.

Using this method, we decomposed (100 times the natural log of) each of the
six time series. After that, following Fiorito and Kollintzas (1994) and Serletis
and Kemp (1998), the magnitudes and signs of the cross-correlations between the
resulting cyclical components of the macroeconomic time series and stock indices
were examined. The magnitudes revealed the strengths of the cyclical associations,
whereas the signs revealed their directions. Specifically, the cross-correlations of the
cyclical component of a macroeconomic time series, mt, with that of a stock index,
st + l, were denoted by ρ(l), where l ∈ (0, ±1, 2, …6). If the maximum value of |ρ(l)|
was obtained for a negative (positive) value of l, then the stock index, st, was con-
sidered to lead (lag) the macroeconomic series, mt. The two series were considered
synchronous if the maximum value of |ρ(l)| occurred at l = 0.

4
The
�∑Hodrick-Prescott filter yields a smooth trend gt of�a time series yt according to the equation,
T � �2 ∑T−1 �� � � ��2 .
min t=1 y t − gt + 𝜆 t=2 gt+1 − gt − gt − gt−1
gt

13
260 Vatsa P. et al.

Whether the stock index was procyclical, countercyclical, or not associated with
the business cycle was determined by the sign of ρ(0). For positive (negative) values
that were significantly different from 0, st was deemed procyclical (countercyclical).
However, if ρ(0) was close to 0, then st was considered unrelated to the business
cycle. Furthermore, the strengths of the correlations between the cycles were ascer-
tained by the magnitudes of |ρ(0)|. As such, following Smith (1992) and Vatsa and
Miljkovic (2022), for |ρ(0)| less than a threshold θ, st was deemed contemporane-
ously uncorrelated with mt. θ was determined by setting 1.96
√ (the critical value asso-
ciated with the 5% significance level) equal to 𝜌 n − 2∕ 1 − 𝜌2 and then solving
√

for ρ. Next, θ < |ρ(0)| < 0.5 indicated a weak contemporaneous correlation between
the two. Lastly, 0.5 ≤ |ρ(0)| ≤ 1 suggested strong contemporaneous correlation
(Fiorito & Kollintzas, 1994).
It bears emphasizing that although the macroeconomic time series are seasonally
adjusted, the stock indices are not. Ignoring the differences in seasonal properties
across different time series may lead to incorrect conclusions. For example, applying
the Hodrick-Prescott filter to isolate trends from cycles leaves seasonality embedded
in the cyclical component (Buss, 2010). This may lead the researcher to incorrectly
perceive a recurring seasonal pattern as cyclical changes. The cycles may possess
implausible regularity. Thus, it is important to use methods that are robust to differ-
ent seasonal properties of the data. Hamilton (2018) and Vatsa (2021) have convinc-
ingly demonstrated that the Hamilton filter is robust to differences in the seasonal
patterns present in the data.
Although one may use off-the-shelf statistical methods such as X-13 autoregres-
sive integrated moving average (ARIMA) or seasonal-trend decomposition using
locally estimated scatterplot smoothing (LOESS) to derive seasonally adjusted
data and then apply any filtering technique to extract the cyclical components, this
approach is ill-advised on the following grounds. A one-size-fits-all approach that
applies the same adjustment method to multiple series with different seasonal prop-
erties may leave seasonality embedded in some series while removing it from oth-
ers. Consequently, the cyclical components of some series might be free of season-
ality, and those of others might not. One may approach seasonal adjustment more
discriminately by applying different techniques to different series. However, this is
an ad hoc approach, susceptible to the biases and inclinations of the researcher. Sea-
sonal decomposition can be obviated by using filtering techniques that are robust to
the seasonal properties of the data. The Hamilton filter is desirable in this regard.
The Hamilton filter has also come under criticism. For example, Schüler (2018b)
argued that the filter is based on ad hoc assumptions and amplifies cycles that are
longer than regular business cycles while muting the shorter-term fluctuations. Spe-
cifically, Schüler (2018b) questioned the use of the two-year forecast horizon on
which Hamilton based his regression-based filter. However, Schüler (2018b) also
suggested that the Hamilton filter produces more robust cyclical estimates than the
Hodrick-Prescott filter at the end of the samples and, thus, may be used gainfully for
designing policies.
Given the limitations and advantages of the Hamilton and Hodrick-Prescott fil-
ters, using multiple methods to triangulate the results will help mitigate the impact
of the shortcomings of one method or the other. With this in mind, the robustness of

13
Stock Market Cycles & Macro Dynamics 261

the results obtained from the Hamilton filter was confirmed using a simple random
walk model. As the analysis used monthly data and considered a two-year forecast
horizon, Eq. (5) can be used to approximate the cyclical components as:
v̂ t+24 = yt+24 − yt . (5)
In large samples, Eq. (1) converges to Eq. (5), with v̂ t+24 capturing how much the
series changes over two years (Hamilton, 2018). Equation (5) presents an intuitive
and simple filtering technique that can be readily implemented to verify the results
obtained from alternate methods. The cross-correlations obtained from Eq. (5) are
presented as comparators for those obtained from Eq. (4). Last, the Hodrick-Prescott
filter was used to derive stock market and macroeconomic cycles and to estimate
correlations between them. After all, the Hamilton filter has been put forth as a bet-
ter alternative to the Hodrick-Prescott filter. A comparison of the results yielded by
the two filters is in order.

Data

Data on the S&P 500, the Dow, and Nasdaq were sourced from the Datastream
database (Refinitiv, 2020). The macroeconomic data were obtained from the Fed-
eral Reserve Economic Data (FRED) database (Federal Reserve Bank of St. Louis.,
2020). Monthly data from January 1980 to April 2020 were used for each series
except for the Dow, for which data from January 1986 to April 2020 were used.5 The
IPI was used instead of the real gross domestic product (GDP) as monthly data for
the latter were unavailable. The timeliness with which the IPI is reported makes it
a useful barometer of real macroeconomic activity. Another advantage of using the
IPI is that it is more sensitive to short-run fluctuations in economic activity than the
real GDP and can capture sudden changes in demand, supply chain disruptions, and
other shocks stemming from trade policy and movements in exchange rates. Further-
more, using quarterly data, the highest frequency for the real GDP, may not reveal
the cyclical variations in stock market activity as clearly as monthly data, defeating
one of the primary objectives of this study. NFE, which accounts for approximately
80% of the workers contributing to the total U.S. output, was used to confirm the
results obtained using the IPI. Together, the two variables provide a more compre-
hensive view of the nexus between the real macroeconomy and various stock indi-
ces. Last, the CPI was used to study the link between inflation and the stock market.
The macroeconomic variables and the stock indices are plotted in Figs. 1 and 2,
respectively. These provide useful insights into the trends and patterns in, correla-
tions among, and stationarity properties of the data. All the variables trend upward
throughout the sample period. Among the macroeconomic variables, the IPI and
NFE exhibited similar patterns. However, the CPI behaved somewhat differently. It
followed an approximately linear trend in the long run, showing no notable changes

5
Although obtaining higher-frequency stock market data is possible, macroeconomic data are unavail-
able at frequencies higher than monthly.

13
262 Vatsa P. et al.

320 160,000

280 150,000

240 140,000
130,000
IPI and CPI

200

NFE
160 120,000

120 110,000

80 100,000
40 90,000
0 80,000
1980 1985 1990 1995 2000 2005 2010 2015 2020

IPI NFE CPI

Fig. 1  Macroeconomic series (1980–2020): Industrial production index, non-farm employment, CPI.
Data sources: FRED (Federal Reserve Bank of St. Louis, 2020) and Datastream (Refinitiv, 2020)

12,000 30,000

10,000 25,000
S&P and Nasdaq

8,000 20,000

Dow
6,000 15,000

4,000 10,000

2,000 5,000

0 0
1980 1985 1990 1995 2000 2005 2010 2015 2020

S&P 500 Dow Nasdaq

Fig. 2  Trends in the S&P 500, the Dow, and Nasdaq. For the S&P and Nasdaq, data from January 1980
to April 2020 are shown. For the Dow, data from January 1986 to April 2020 are shown, Data sources:
FRED (Federal Reserve Bank of St. Louis, 2020) and Datastream (Refinitiv, 2020)

even during the recessionary phases. The three stock indices show strikingly similar
behaviors, rising and falling together.

Empirical Evidence

Figures 3, 4, and 5 illustrate stock market cycles relative to macroeconomic cycles

derived using the Hamilton filter. Figure 3 presents cycles in the three U.S. stock
indices relative to the IPI since 1980, while Fig. 4 substitutes NFE for industrial
production. Figure 5 examines U.S. stock market cycles relative to the U.S. inflation
rate.

13
Stock Market Cycles & Macro Dynamics 263

160 12
120 8
80 4
Stock Indices

40 0

IPI
0 -4
-40 -8
-80 -12
-120 -16
-160 -20
1980 1985 1990 1995 2000 2005 2010 2015 2020

S&P 500 Dow Nasdaq IPI

Fig. 3  Stock market cycles relative to output cycles (Dec. 1982-Apr. 2020). Cycles for the Dow are for
the period December 1988–April 2020. Data sources: FRED (Federal Reserve Bank of St. Louis, 2020)
and Datastream (Refinitiv, 2020)

120 12

80 8

40 4
Stock Indices

0 0

NFE
-40 -4

-80 -8

-120 -12

-160 -16
1980 1985 1990 1995 2000 2005 2010 2015 2020

S&P 500 Dow Nasdaq NFE

Fig. 4  Stock mrket cycles relative to employment cycles (Dec. 1982-April 2020). Cycles for the Dow
are for the period December 1988–April 2020. Data sources: FRED (Federal Reserve Bank of St. Louis,
2020) and Datastream (Refinitiv, 2020)

The correlations and the summary statistics in Table 1 support the observations
noted above. First, the monthly growth rates of the three stock indices are strongly
correlated. Second, the IPI is strongly correlated with only the NFE. Third, inflation
is uncorrelated with the growth rates of the other variables. Fourth, and surprisingly,
the monthly growth rate of the IPI is uncorrelated with those of the various stock
market indices.
Noting the general upward trends in the six time series, two deterministic regres-
sors were included, namely the intercept and a linear trend, to examine the stationary

13
264 Vatsa P. et al.

160 4
120 3
80 2
40 1
Stock Indices

Inflation
0 0
-40 -1
-80 -2
-120 -3
-160 -4
-200 -5
1980 1985 1990 1995 2000 2005 2010 2015 2020

S&P 500 Dow Nasdaq Inflation

Fig. 5  Stock mrket cycles relative to inflation (Dec. 1982-April 2020). Cycles for the Dow are for the
period December 1988–April 2020. Data sources: FRED (Federal Reserve Bank of St. Louis, 2020) and
Datastream (Refinitiv, 2020)

Table 1  Summary statistics of and cross-correlations between stock market and macroeconomic time
series

IPI NFE CPI S&P 500 Dow Nasdaq

Panel A
Mean 82.6 122,066.7 172.0 1171.1 10,235.7 2145.6
Max 110.6 152,463.0 259.0 3230.8 28,538.4 9150.9
Min 48.2 88,771.0 78.0 211.8 1570.9 131
Std. Dev. 19.6 17,958.6 51.3 728.1 6583.6 2070.7
CoV 23.8 14.7 29.8 62.2 64.3 96.5
Observations 484 484 484 484 412 484
Panel B
IPI 1.00 0.73 0.20 −0.08 −0.07 −0.09
NFE 0.73 1.00 0.22 −0.08 −0.07 −0.08
CPI 0.20 0.22 1.00 −0.01 −0.02 −0.02
S&P 500 −0.08 −0.08 −0.01 1.00 0.96 0.86
Dow −0.07 −0.07 −0.02 0.96 1.00 0.78
Nasdaq −0.09 −0.08 −0.02 0.86 0.78 1.00

CoV denotes the coefficient of variation. Panel B shows correlations between growth rates. The estimates
are based on the full sample from January 1980 to April 2020 for every series except for the Dow, for
which data from January 1986 to April 2020 were used. Data sources: FRED (Federal Reserve Bank of
St. Louis, 2020) and Datastream (Refinitiv, 2020)

13
Stock Market Cycles & Macro Dynamics 265

Table 2  Results of Phillips-Perron unit root tests

IPI NFE CPI S&P 500 Dow Nasdaq

Drift and Trend

Test Statistics 0.123 0.081 −4.419** −1.918 −2.250 −2.485
Drift −2.163 −4.332 6.490** 7.896* 16.945* 12.376*
Trend −0.001 −0.001 0.002** 0.008 0.011 0.016*
Drift Only
Test Statistics −1.566 −1.982 −6.893** −0.002 −1.667 −1.263
Drift 1.368* 5.131* 2.088 2.440 4.967 2.440
Observations 483 483 483 483 411 483

**(*) denotes rejection of the null hypothesis that a unit root is present at the 0.01(0.05) significance
level. The unit root tests are conducted for the full sample. Data sources: FRED (Federal Reserve Bank
of St. Louis, 2020) and Datastream (Refinitiv, 2020)

properties of the series. The drawback of including both deterministic terms is that
estimating unnecessary parameters reduces degrees of freedom and the power of
unit root tests. However, incorrectly ignoring the trend may reduce the power of the
test to zero. Therefore, unit root tests without the linear trend were also conducted
where necessary.
The results of the Phillips and Perron (1988) unit root tests presented in Table 2
suggest that the CPI is trend-stationary.6 The other five series are non-stationary.
The cross-correlations between the macroeconomic time series and the stock indi-
ces, estimated using the Hamilton filter, the random walk model, and the Hodrick-
Prescott filter, are presented in Tables 3, 4, 5, 6. As correlations can change over
time, the results are presented in separate tables for each of the four decades between
1980 and 2020.
Consider the cross-correlations between the IPI and the three stock indices dur-
ing the 1980s presented in Table 3. Although the three methods yield correlation
coefficients of different magnitudes, overall, the evidence points to the stock indices
being weakly countercyclical. The random walk model, however, suggests strong
countercyclicality in the case of the Dow. The contemporaneous cross-correlations
between the stock indices and NFE were negative and greater than −0.5, indicat-
ing a weakly negative association between them. The contemporaneous correlations
between stock indices and inflation were also negative, albeit larger than those for
IPI and NFE. The bottom panel shows that the three stock indices were strongly and
positively correlated. Moreover, the correlations ρ(0) are the strongest, signifying
that the stock indices exhibited strong co-movement.
In the 1990s, the correlations between stock market cycles and the macroeco-
nomic variables changed markedly. Table 4 shows that stock markets were strongly
procyclical during this period. Both the Hamilton filter and the random walk model

{ (( ) )}
0.25
6
According to Schwert (1989), the lag length is determined using the formula Int 4 100
T
.

13
 Table 3  Cross-correlations: Stock indices and the macroeconomy; January 1980 to December 1990
266

Filter ρ (6) ρ (5) ρ (4) ρ (3) ρ (2) ρ (1) ρ (0) ρ (−1) ρ (−2) ρ (−3) ρ (−4) ρ (−5) ρ (−6)

13
Corr. with IPI
S&P 500 HF 0.13 0.02 −0.04 −0.12 −0.20 −0.29 −0.38 −0.41 −0.47 −0.50 −0.51 −0.51 −0.50
HP 0.39 0.35 0.29 0.19 0.06 −0.07 −0.20 −0.29 −0.37 −0.45 −0.51 −0.54 −0.55
RW 0.42 0.36 0.30 0.24 0.16 0.08 −0.01 −0.09 −0.17 −0.24 −0.30 −0.34 −0.37
Nasdaq HF −0.05 −0.16 −0.21 −0.27 −0.33 −0.41 −0.45 −0.47 −0.48 −0.51 −0.49 −0.49 −0.46
HP 0.35 0.31 0.27 0.16 0.04 −0.10 −0.23 −0.32 −0.40 −0.47 −0.52 −0.54 −0.55
RW 0.11 0.05 −0.02 −0.08 −0.15 −0.23 −0.31 −0.39 −0.45 −0.51 −0.54 −0.56 −0.56
Dow HF −0.43 −0.40 −0.27 −0.16 −0.03 −0.14 −0.34 −0.23 −0.11 −0.03 0.32 0.35 0.23
HP 0.18 0.05 0.02 −0.02 −0.12 −0.23 −0.34 −0.43 −0.49 −0.54 −0.56 −0.58 −0.56
RW −0.29 −0.40 −0.44 −0.44 −0.46 −0.50 −0.58 −0.61 −0.63 −0.68 −0.67 −0.63 −0.58
Corr. with NFE
S&P 500 HF 0.15 0.08 0.01 −0.03 −0.08 −0.12 −0.21 −0.26 −0.30 −0.32 −0.31 −0.34 −0.32
HP 0.25 0.21 0.14 0.06 −0.04 −0.13 −0.22 −0.28 −0.34 −0.39 −0.42 −0.44 −0.44
RW 0.36 0.32 0.28 0.24 0.21 0.16 0.10 0.05 0.00 −0.04 −0.07 −0.10 −0.11
Nasdaq HF 0.00 −0.09 −0.15 −0.17 −0.22 −0.26 −0.32 −0.36 −0.36 −0.39 −0.38 −0.39 −0.36
HP 0.22 0.18 0.11 0.02 −0.08 −0.17 −0.26 −0.34 −0.40 −0.45 −0.48 −0.50 −0.50
RW −0.07 −0.11 −0.15 −0.17 −0.19 −0.23 −0.27 −0.31 −0.35 −0.39 −0.40 −0.40 −0.39
Dow HF −0.55 −0.52 −0.48 −0.22 −0.02 −0.05 −0.24 −0.16 −0.01 0.13 0.45 0.25 0.35
HP 0.00 −0.04 −0.06 −0.06 −0.07 −0.10 −0.12 −0.14 −0.14 −0.17 −0.17 −0.18 −0.18
RW −0.59 −0.63 −0.63 −0.54 −0.46 −0.44 −0.44 −0.40 −0.40 −0.42 −0.36 −0.32 −0.25
Corr. with CPI
S&P 500 HF −0.42 −0.46 −0.49 −0.50 −0.51 −0.51 −0.51 −0.51 −0.46 −0.41 −0.37 −0.33 −0.31
HP 0.03 −0.05 −0.14 −0.23 −0.33 −0.40 −0.44 −0.44 −0.41 −0.38 −0.35 −0.33 −0.34
RW −0.63 −0.66 −0.67 −0.69 −0.70 −0.70 −0.68 −0.63 −0.57 −0.50 −0.44 −0.36 −0.30
Vatsa P. et al.
 Table 3  (continued)
Filter ρ (6) ρ (5) ρ (4) ρ (3) ρ (2) ρ (1) ρ (0) ρ (−1) ρ (−2) ρ (−3) ρ (−4) ρ (−5) ρ (−6)

Nasdaq HF −0.51 −0.55 −0.56 −0.58 −0.59 −0.59 −0.60 −0.59 −0.54 −0.48 −0.44 −0.39 −0.37
HP −0.01 −0.07 −0.15 −0.26 −0.36 −0.44 −0.49 −0.48 −0.44 −0.37 −0.30 −0.26 −0.26
RW −0.36 −0.38 −0.39 −0.43 −0.46 −0.46 −0.43 −0.37 −0.29 −0.19 −0.11 −0.03 0.02
Dow HF 0.67 0.73 0.76 0.69 0.48 0.24 0.06 −0.16 −0.24 −0.26 −0.39 −0.34 −0.40
HP 0.18 0.21 0.20 0.14 0.01 −0.09 −0.16 −0.19 −0.18 −0.18 −0.18 −0.21 −0.30
RW 0.53 0.65 0.72 0.68 0.56 0.44 0.36 0.30 0.27 0.31 0.34 0.34 0.30
Corr. with S&P 500
Stock Market Cycles & Macro Dynamics

Nasdaq HF 0.43 0.50 0.54 0.59 0.66 0.79 0.86 0.71 0.55 0.43 0.34 0.28 0.21
HP 0.15 0.28 0.38 0.51 0.65 0.81 0.93 0.80 0.62 0.44 0.29 0.19 0.07
RW 0.49 0.56 0.60 0.65 0.72 0.81 0.85 0.72 0.56 0.42 0.30 0.22 0.12
Dow HF −0.03 −0.03 −0.04 0.01 0.24 0.61 0.95 0.72 0.31 −0.02 −0.30 −0.23 0.03
HP −0.05 0.04 0.10 0.25 0.47 0.74 0.97 0.80 0.57 0.39 0.25 0.18 0.11
RW 0.08 0.15 0.17 0.29 0.46 0.71 0.97 0.80 0.61 0.48 0.38 0.34 0.32

The thresholds for the HF, HP, and RW for the Dow are 0.43, 0.26, and 0.35, respectively; in other cases, the thresholds are 0.20, 0.19, and 0.17. Thresholds vary due to
differences in the sample sizes available for the cyclical components derived from the three methods. The Ns for the Dow are 19 (HF), 54 (HP), and 30 (RW). For the Nas-
daq and the S&P 500, they are 91 (HF), 126 (HP), and 102 (RW). Data sources: FRED (Federal Reserve Bank of St. Louis, 2020) and Datastream (Refinitiv, 2020)
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 Table 4  Cross-correlations: Stock indices and the macroeconomy; January 1990 to December 1999
268

Filter ρ (6) ρ (5) ρ (4) ρ (3) ρ (2) ρ (1) ρ (0) ρ (−1) ρ (−2) ρ (−3) ρ (−4) ρ (−5) ρ (−6)

13
Corr. with IPI
S&P 500 HF 0.65 0.68 0.70 0.71 0.71 0.71 0.71 0.71 0.71 0.72 0.73 0.74 0.75
HP 0.23 0.22 0.21 0.13 0.03 −0.11 −0.20 −0.21 −0.20 −0.17 −0.14 −0.11 −0.10
RW 0.54 0.55 0.57 0.57 0.57 0.58 0.58 0.58 0.59 0.61 0.62 0.64 0.65
Nasdaq HF 0.71 0.72 0.74 0.75 0.73 0.71 0.67 0.64 0.62 0.60 0.60 0.60 0.61
HP 0.18 0.17 0.18 0.13 0.04 −0.08 −0.17 −0.18 −0.14 −0.11 −0.10 −0.10 −0.08
RW 0.63 0.64 0.64 0.63 0.61 0.58 0.53 0.50 0.49 0.47 0.47 0.48 0.48
Dow HF 0.71 0.73 0.75 0.75 0.75 0.74 0.74 0.73 0.73 0.74 0.74 0.74 0.74
HP 0.29 0.28 0.27 0.20 0.08 −0.07 −0.17 −0.19 −0.22 −0.23 −0.23 −0.21 −0.23
RW 0.58 0.58 0.59 0.59 0.58 0.58 0.58 0.58 0.58 0.60 0.60 0.62 0.62
Corr. with NFE
S&P 500 HF 0.47 0.49 0.49 0.49 0.48 0.47 0.46 0.46 0.47 0.48 0.49 0.48 0.48
HP 0.08 0.00 −0.10 −0.20 −0.26 −0.31 −0.35 −0.36 −0.38 −0.38 −0.35 −0.36 −0.35
RW 0.32 0.33 0.35 0.36 0.36 0.36 0.36 0.36 0.37 0.38 0.39 0.39 0.40
Nasdaq HF 0.60 0.60 0.57 0.54 0.51 0.46 0.41 0.39 0.38 0.38 0.38 0.37 0.37
HP 0.10 0.04 −0.05 −0.13 −0.20 −0.24 −0.26 −0.25 −0.23 −0.22 −0.21 −0.23 −0.22
RW 0.37 0.35 0.32 0.29 0.26 0.22 0.19 0.17 0.16 0.15 0.15 0.14 0.14
Dow HF 0.51 0.53 0.53 0.54 0.53 0.52 0.51 0.51 0.52 0.53 0.53 0.52 0.52
HP 0.10 0.05 −0.03 −0.10 −0.15 −0.20 −0.23 −0.24 −0.27 −0.29 −0.29 −0.31 −0.33
RW 0.37 0.39 0.41 0.43 0.43 0.44 0.44 0.45 0.46 0.46 0.46 0.46 0.46
Corr. with CPI
S&P 500 HF −0.52 −0.52 −0.52 −0.52 −0.54 −0.56 −0.57 −0.57 −0.56 −0.55 −0.54 −0.53 −0.54
HP −0.12 −0.18 −0.21 −0.25 −0.32 −0.34 −0.36 −0.29 −0.20 −0.13 −0.06 −0.00 0.01
RW −0.48 −0.48 −0.47 −0.47 −0.49 −0.51 −0.53 −0.53 −0.52 −0.52 −0.50 −0.51 −0.51
Vatsa P. et al.
 Table 4  (continued)
Filter ρ (6) ρ (5) ρ (4) ρ (3) ρ (2) ρ (1) ρ (0) ρ (−1) ρ (−2) ρ (−3) ρ (−4) ρ (−5) ρ (−6)

Nasdaq HF −0.75 −0.75 −0.75 −0.76 −0.78 −0.78 −0.77 −0.75 −0.72 −0.70 −0.69 −0.68 −0.68
HP 0.03 −0.04 −0.09 −0.16 −0.24 −0.28 −0.30 −0.27 −0.22 −0.19 −0.17 −0.16 −0.19
RW −0.68 −0.68 −0.68 −0.69 −0.71 −0.73 −0.72 −0.71 −0.69 −0.67 −0.66 −0.66 −0.66
Dow HF −0.51 −0.50 −0.49 −0.49 −0.50 −0.51 −0.53 −0.53 −0.52 −0.52 −0.51 −0.50 −0.51
HP 0.09 0.03 −0.02 −0.06 −0.14 −0.18 −0.21 −0.18 −0.11 −0.04 0.03 0.08 0.10
RW −0.43 −0.42 −0.40 −0.39 −0.40 −0.43 −0.45 −0.45 −0.44 −0.44 −0.43 −0.43 −0.43
Corr. with S&P 500
Stock Market Cycles & Macro Dynamics

Nasdaq HF 0.66 0.65 0.66 0.70 0.73 0.77 0.80 0.76 0.72 0.69 0.66 0.65 0.66
HP −0.08 −0.05 0.01 0.15 0.35 0.58 0.81 0.64 0.49 0.32 0.19 0.11 0.15
RW 0.54 0.53 0.55 0.59 0.64 0.68 0.72 0.66 0.61 0.56 0.52 0.50 0.52
Dow HF 0.88 0.87 0.87 0.89 0.91 0.92 0.96 0.91 0.88 0.84 0.81 0.78 0.76
HP −0.06 −0.10 −0.07 0.09 0.35 0.56 0.89 0.65 0.44 0.25 0.14 0.10 0.03
RW 0.80 0.79 0.79 0.82 0.85 0.88 0.93 0.86 0.81 0.76 0.70 0.67 0.63

The threshold, θ, is 0.18. N = 120. Data sources: FRED (Federal Reserve Bank of St. Louis, 2020) and Datastream (Refinitiv, 2020)
269

13
 Table 5  Cross-correlations: Stock indices and the macroeconomy; January 2000 to December 2009
270

Filter ρ (6) ρ (5) ρ (4) ρ (3) ρ (2) ρ (1) ρ (0) ρ (−1) ρ (−2) ρ (−3) ρ (−4) ρ (−5) ρ (−6)

13
Corr. with IPI
S&P 500 HF 0.70 0.74 0.78 0.81 0.83 0.83 0.82 0.82 0.79 0.75 0.71 0.68 0.64
HP 0.65 0.72 0.77 0.81 0.80 0.75 0.69 0.62 0.52 0.40 0.29 0.20 0.10
RW 0.71 0.76 0.79 0.82 0.84 0.84 0.83 0.82 0.80 0.76 0.73 0.69 0.65
Nasdaq HF 0.53 0.57 0.60 0.62 0.63 0.63 0.63 0.62 0.60 0.57 0.53 0.49 0.45
HP 0.56 0.61 0.64 0.66 0.64 0.58 0.52 0.47 0.39 0.29 0.20 0.13 0.05
RW 0.56 0.59 0.62 0.64 0.65 0.65 0.64 0.62 0.60 0.56 0.52 0.48 0.43
Dow HF 0.70 0.75 0.80 0.84 0.86 0.86 0.86 0.86 0.83 0.80 0.76 0.73 0.69
HP 0.63 0.70 0.76 0.80 0.79 0.75 0.69 0.63 0.53 0.41 0.30 0.21 0.12
RW 0.71 0.76 0.81 0.84 0.86 0.87 0.87 0.86 0.84 0.80 0.77 0.74 0.69
Corr. with NFE
S&P 500 HF 0.80 0.83 0.84 0.86 0.87 0.86 0.84 0.81 0.77 0.73 0.68 0.65 0.61
HP 0.82 0.83 0.80 0.76 0.70 0.61 0.50 0.40 0.30 0.19 0.09 0.02 – 0.04
RW 0.90 0.91 0.91 0.90 0.89 0.86 0.83 0.79 0.75 0.69 0.64 0.59 0.53
Nasdaq HF 0.66 0.68 0.69 0.70 0.71 0.70 0.68 0.65 0.61 0.57 0.52 0.48 0.44
HP 0.68 0.66 0.63 0.58 0.51 0.43 0.34 0.25 0.17 0.08 −0.01 −0.07 −0.13
RW 0.75 0.75 0.74 0.72 0.70 0.67 0.63 0.59 0.53 0.47 0.41 0.35 0.28
Dow HF 0.78 0.81 0.84 0.86 0.87 0.86 0.84 0.82 0.79 0.75 0.72 0.69 0.64
HP 0.78 0.79 0.78 0.74 0.68 0.60 0.50 0.40 0.30 0.19 0.10 0.03 −0.03
RW 0.87 0.89 0.89 0.89 0.89 0.87 0.84 0.81 0.77 0.72 0.68 0.64 0.59
Corr. with CPI
S&P 500 HF 0.65 0.65 0.64 0.62 0.60 0.56 0.50 0.44 0.37 0.30 0.22 0.17 0.12
HP 0.40 0.44 0.47 0.49 0.49 0.43 0.33 0.22 0.10 −0.05 −0.21 −0.33 −0.41
RW 0.75 0.74 0.72 0.69 0.67 0.62 0.56 0.49 0.42 0.34 0.26 0.20 0.14
Vatsa P. et al.
 Table 5  (continued)
Filter ρ (6) ρ (5) ρ (4) ρ (3) ρ (2) ρ (1) ρ (0) ρ (−1) ρ (−2) ρ (−3) ρ (−4) ρ (−5) ρ (−6)

Nasdaq HF 0.53 0.53 0.51 0.48 0.45 0.42 0.37 0.32 0.27 0.22 0.16 0.12 0.08
HP 0.32 0.33 0.33 0.32 0.30 0.25 0.16 0.06 −0.04 −0.15 −0.27 −0.34 −0.38
RW 0.59 0.57 0.54 0.50 0.46 0.41 0.36 0.29 0.22 0.15 0.08 0.03 −0.03
Dow HF 0.63 0.63 0.62 0.60 0.59 0.55 0.49 0.44 0.38 0.30 0.22 0.17 0.12
HP 0.39 0.43 0.45 0.47 0.47 0.41 0.32 0.24 0.13 −0.01 −0.17 −0.29 −0.38
RW 0.73 0.72 0.71 0.69 0.67 0.62 0.56 0.50 0.43 0.35 0.27 0.22 0.16
Corr. with S&P 500
Stock Market Cycles & Macro Dynamics

Nasdaq HF 0.73 0.76 0.80 0.82 0.85 0.87 0.89 0.85 0.81 0.77 0.72 0.66 0.60
HP 0.42 0.50 0.59 0.65 0.71 0.78 0.83 0.72 0.61 0.52 0.40 0.28 0.17
RW 0.74 0.77 0.80 0.83 0.85 0.87 0.88 0.84 0.79 0.74 0.68 0.62 0.55
Dow HF 0.67 0.73 0.78 0.83 0.87 0.92 0.97 0.95 0.92 0.90 0.86 0.81 0.76
HP 0.28 0.40 0.52 0.63 0.72 0.85 0.96 0.89 0.79 0.71 0.61 0.48 0.35
RW 0.67 0.73 0.78 0.83 0.87 0.92 0.96 0.94 0.92 0.89 0.85 0.80 0.74

The threshold, θ, is 0.18. N = 120. Data sources: FRED (Federal Reserve Bank of St. Louis, 2020) and Datastream (Refinitiv, 2020)
271

13
 Table 6  Cross-Correlations: Stock indices and the macroeconomy; January 2010 to December 2019
272

Filter ρ (6) ρ (5) ρ (4) ρ (3) ρ (2) ρ (1) ρ (0) ρ (−1) ρ (−2) ρ (−3) ρ (−4) ρ (−5) ρ (−6)

13
Corr. with IPI
S&P 500 HF 0.65 0.67 0.69 0.73 0.75 0.74 0.74 0.74 0.71 0.65 0.57 0.48 0.34
HP 0.48 0.46 0.44 0.45 0.40 0.34 0.30 0.28 0.28 0.29 0.28 0.21 0.13
RW 0.74 0.77 0.79 0.80 0.80 0.77 0.74 0.69 0.63 0.55 0.45 0.33 0.19
Nasdaq HF 0.61 0.63 0.64 0.70 0.71 0.68 0.67 0.67 0.64 0.58 0.51 0.42 0.29
HP 0.46 0.45 0.43 0.46 0.40 0.34 0.29 0.27 0.28 0.29 0.29 0.24 0.16
RW 0.73 0.75 0.75 0.76 0.74 0.69 0.63 0.57 0.50 0.42 0.32 0.20 0.06
Dow HF 0.72 0.73 0.75 0.79 0.80 0.79 0.79 0.78 0.74 0.67 0.59 0.48 0.34
HP 0.58 0.55 0.54 0.54 0.49 0.44 0.40 0.38 0.37 0.36 0.31 0.21 0.12
RW 0.81 0.83 0.85 0.86 0.86 0.82 0.78 0.73 0.65 0.55 0.44 0.30 0.14
Corr. with NFE
S&P 500 HF 0.70 0.71 0.73 0.75 0.78 0.79 0.76 0.70 0.62 0.54 0.45 0.31 0.18
HP 0.17 0.07 0.02 −0.01 −0.06 −0.08 −0.10 −0.13 −0.12 −0.07 −0.05 −0.15 −0.24
RW 0.78 0.75 0.71 0.66 0.60 0.54 0.46 0.38 0.30 0.22 0.14 0.03 −0.08
Nasdaq HF 0.67 0.68 0.69 0.71 0.72 0.72 0.69 0.62 0.54 0.46 0.38 0.26 0.16
HP 0.08 −0.00 −0.06 −0.08 −0.13 −0.17 −0.19 −0.24 −0.24 −0.19 −0.15 −0.20 −0.26
RW 0.67 0.63 0.58 0.52 0.44 0.36 0.28 0.19 0.12 0.06 −0.01 −0.10 −0.19
Dow HF 0.68 0.69 0.70 0.72 0.74 0.75 0.73 0.68 0.63 0.56 0.48 0.36 0.23
HP 0.29 0.19 0.13 0.09 0.04 0.03 −0.00 −0.04 −0.04 −0.01 −0.02 −0.15 −0.26
RW 0.75 0.71 0.67 0.62 0.57 0.50 0.43 0.34 0.26 0.18 0.09 −0.02 −0.13
Corr. with CPI
S&P 500 HF 0.38 0.41 0.44 0.48 0.52 0.56 0.53 0.48 0.41 0.32 0.21 0.11 0.03
HP 0.23 0.21 0.19 0.22 0.25 0.30 0.25 0.16 0.09 0.04 −0.00 −0.05 −0.09
RW 0.36 0.39 0.42 0.47 0.51 0.53 0.49 0.43 0.35 0.24 0.13 0.03 −0.05
Vatsa P. et al.
 Table 6  (continued)
Filter ρ (6) ρ (5) ρ (4) ρ (3) ρ (2) ρ (1) ρ (0) ρ (−1) ρ (−2) ρ (−3) ρ (−4) ρ (−5) ρ (−6)

Nasdaq HF 0.36 0.38 0.40 0.44 0.48 0.52 0.48 0.42 0.34 0.25 0.14 0.06 0.00
HP 0.17 0.13 0.12 0.14 0.16 0.22 0.18 0.09 0.04 0.00 −0.03 −0.07 −0.09
RW 0.35 0.37 0.39 0.43 0.46 0.47 0.41 0.32 0.22 0.11 −0.00 −0.09 −0.15
Dow HF 0.53 0.56 0.59 0.63 0.68 0.71 0.69 0.65 0.60 0.52 0.42 0.31 0.22
HP 0.33 0.30 0.28 0.30 0.33 0.38 0.33 0.24 0.19 0.16 0.12 0.07 0.02
RW 0.51 0.54 0.57 0.61 0.65 0.66 0.63 0.57 0.49 0.39 0.27 0.15 0.05
Corr. with S&P 500
Stock Market Cycles & Macro Dynamics

Nasdaq HF 0.52 0.59 0.67 0.75 0.81 0.89 0.96 0.86 0.77 0.67 0.55 0.39 0.25
HP 0.03 0.13 0.17 0.31 0.45 0.64 0.94 0.70 0.54 0.40 0.28 0.24 0.18
RW 0.46 0.55 0.65 0.74 0.81 0.88 0.95 0.85 0.73 0.61 0.46 0.28 0.11
Dow HF 0.59 0.63 0.69 0.75 0.81 0.87 0.94 0.87 0.80 0.72 0.60 0.45 0.29
HP 0.10 0.18 0.23 0.35 0.50 0.67 0.94 0.66 0.47 0.34 0.22 0.17 0.10
RW 0.51 0.58 0.66 0.73 0.80 0.88 0.94 0.86 0.77 0.66 0.52 0.33 0.15

The threshold, θ, is 0.18. N = 118. Data sources: FRED (Federal Reserve Bank of St. Louis, 2020) and Datastream (Refinitiv, 2020)
273

13
274 Vatsa P. et al.

yielded similar findings. The Hodrick-Prescott filter, on the other hand, produced
starkly different results, suggesting that while the S&P 500 was weakly countercy-
clical, the Nasdaq and the Dow were not contemporaneously correlated with the
business cycle. The correlations between the stock market cycles and inflation were
negative. The results produced by the Hamilton filter and the random walk model
were quite similar. These methods produced much stronger correlations than the
Hodrick-Prescott filter. The Nasdaq and the Dow continued to show strong co-move-
ment with the S&P 500 during the 1990s.
The correlations for the 2000s are presented in Table 5. Once again, the Hamilton
filter and the random walk model produced similar results, showing that all three
stock indices were strongly procyclical. The contemporaneous correlations with the
IPI were above 0.80 for the S&P 500 and the Dow and greater than 0.60 for the
Nasdaq. Although the Hodrick-Prescott filter produced smaller correlations than the
other two filters, the correlations were large enough to lead one to the same conclu-
sion. Stock markets were strongly procyclical in the 2000s. The correlations of the
stock indices with NFE corroborate this evidence.
As for the lead-lag associations, the maximum values of the correlations of the
stock indices with the IPI and NFE were observed for l > 0, indicating that stock
markets lagged business cycles. In the case of the IPI, the maximum values were
observed for 1 ≤ l ≤ 3. The results showed evidence of a strong positive contempora-
neous correlation between inflation and the S&P 500. The evidence was mixed for
the Nasdaq and the Dow, with the correlations being slightly larger for the latter. In
each case, the Hodrick-Prescott filter produced noticeably lower correlations. Apro-
pos the lead-lag associations, there is compelling evidence that stock market cycles
lagged inflation during the 2000s.
The results for the 2010s presented in Table 6 bear a striking resemblance to
those for the 2000s, suggesting that the associations between the stock market and
macroeconomic cycles remained relatively stable during the first two decades of the
twenty-first century. The contemporaneous correlations between the stock indices
and the IPI were positive and greater than 0.60 per the Hamilton filter and the ran-
dom walk model. The Hodrick-Prescott filter produced positive correlations, albeit
considerably smaller in magnitude. For NFE, the Hamilton filter and the random
walk model produced positive correlations, precisely what one might expect given
the procyclicality of stock indices evidenced by their positive correlations with the
IPI. Furthermore, given that the maximum value of |ρ(l)| occurred at l > 0, we con-
clude that stock markets lagged macroeconomic activity during the 2010s.
In contrast to the Hamilton filter and the random walk model, the Hodrick-
Prescott filter yielded negative correlations between the NFE and stock index cycles.
This brings the veracity of the Hodrick-Prescott filter into question. If stock indi-
ces are procyclical, they should be positively correlated with NFE. However, the
Hodrick-Prescott filter generated positive correlations between the stock market
indices and the IPI and negative ones between the indices and NFE. These results
are inconsistent and counterintuitive.
The relationship between inflation and stock market cycles was positive, with the
correlations being the strongest in the case of the Dow. The bottom panel of Table 6

13
Stock Market Cycles & Macro Dynamics 275

shows that the co-movement between the stock indices remained strong during the
2010s, with the correlations ranging between 0.94 and 0.96.
The association between inflation and stock market cycles has changed over time.
During the 1980s, inflation was tamed while the stock markets rose to new heights,
notwithstanding the 1987 crash. The results show a negative association between
inflation and stock market performance during the 1980s. Each of the three filters
suggests that inflation and stock market cycles were inversely related during the
1980s and 1990s, confirming the findings of several previous studies (e.g., Eldo-
miaty et al., 2019; Quayes & Jamal, 2008). The early 1980s experienced high infla-
tion following the oil price shocks in the late 1970s, which sent oil prices spiraling
upward. The Federal Reserve Bank responded by raising the interest rates to stem
inflation. It succeeded, and interest rates started declining toward the end of 1981.
While inflation fell reasonably consistently until 1986, the economy grew apprecia-
bly, boosting investor sentiment and leading to a protracted bull market in the 1980s.
Thus, declining inflation coincided with rising stock prices.
Although the 1990s started with a short-lived recession, the decade was marked
by a long economic boom. The stock market registered impressive gains in the lat-
ter half of the decade; output and employment also increased. The marked increase
in productivity allowed the economy to grow rapidly without building inflationary
pressures. These dynamics help explain why the stock market was negatively associ-
ated with inflation but positively associated with the real economy in the 1990s.
In the twenty-first century, inflation and stock market cycles have shown strong
positive associations. During the 2000s, low interest rates, globalization, high eco-
nomic growth in emerging markets, and the housing credit boom contributed to
demand-pull inflation and abundant liquidity, some of which flowed into the stock
markets, boosting asset prices. During the 2007–2008 global financial crises, stock
markets plummeted, and inflation subsided, reinforcing the positive association.
Prices and stock markets recovered in the aftermath of the crisis and on the back of
fiscal stimuli and quantitative easing. Then, in 2014–2015, a glut in the oil markets
and the Organization of the Petroleum Exporting Countries’ refusal to cut supplies
caused commodity prices to fall precipitously. In parallel, the global economic slow-
down, China’s stock market turmoil, the Greek debt default, and monetary policy
uncertainty contributed to declines in stock indices.

Summary and Conclusion

This study used various filtering techniques to isolate cyclical components from
the U.S. stock indices and macroeconomic variables. Time-difference analysis
was conducted to explore lead-lag relationships between the stock index and mac-
roeconomic cycles. As correlations and lead-lag associations may change over
time, the period 1980–2020 was split into four decade-long subsets. Three core
findings emerged: First, stock markets shifted from being countercyclical in the
1980s and 1990s to being procyclical in the twenty-first century when they trailed
business cycles by 1–3 months. Second, correlations between stock markets and
inflation turned positive in the 2000s and 2010s after being negative in the 1980s

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276 Vatsa P. et al.

and the 1990s. Finally, results diverged considerably between filtering techniques.
The Hamilton filter and random walk models produced broadly consistent results,
while those generated by the Hodrick-Prescott filter differed substantially.
Specifically, the Hodrick-Prescott filter yielded inconsistent correlations
between stock markets and the real economy, positive with industrial produc-
tion, indicating procyclicality, but negative with employment, suggesting coun-
tercyclicality. This produced results that are at odds with commonly held views.
Even though the U.S. stock markets boomed in the 1990s, and the economy grew
appreciably, the results produced by the Hodrick-Prescott filter point to a negative
correlation between the stock market and IPI cycles for that period. The Ham-
ilton filter and random walk results better resonate with established economic
narratives about recent decades. The inconsistencies of the Hodrick-Prescott fil-
ter bring its viability into question. Techniques failing to reproduce well-known
associations between financial markets and the real economy may prove unreli-
able in assessing precise lead-lag relationships.
The results do not support the continued inclusion of the S&P 500 in the Com-
posite Index of Leading Indicators, which is used to predict the direction of the
U.S. economy. They show that the S&P 500 lagged industrial production by one
to three months in recent decades. Interestingly, the Dow shared a stronger cor-
relation with U.S. industrial production than the S&P 500 and Nasdaq during the
twenty-first century.
Previous studies (Apergis & Eleftheriou, 2002; Fama, 1981; Osamwonyi &
Evbayiro-Osagie, 2012) posited a negative association between inflation and
stock market performance. We found this to be the case in the 1980s and 1990s.
However, the correlations were decidedly positive during the 2000s and 2010s,
with inflation leading stock market cycles by one month during the 2010s. The
interlinkages between stock markets and the macroeconomy are dynamic and
complex. This study provides updated evidence on how they are interlinked and
how these interlinkages have evolved over the last 40 years. It stresses the impor-
tance of employing different methods and considering various macroeconomic
variables to gain a comprehensive understanding of the interactions between
stock markets and the broader economy.

Funding Open access funding provided by the Carolinas Consortium.

Data Availability Data of this study are available upon request from the corresponding author.

Open Access This article is licensed under a Creative Commons Attribution 4.0 International License,
which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long
as you give appropriate credit to the original author(s) and the source, provide a link to the Creative
Commons licence, and indicate if changes were made. The images or other third party material in this
article are included in the article’s Creative Commons licence, unless indicated otherwise in a credit line
to the material. If material is not included in the article’s Creative Commons licence and your intended
use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permis-
sion directly from the copyright holder. To view a copy of this licence, visit http://creativecommons.org/
licenses/by/4.0/.

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Stock Market Cycles & Macro Dynamics 277

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