Exploring what stock markets tell us about GDP in theory and practice

Abstract

This paper explores the stock market-GDP relationship from basic theory to simple empirics to better understand what stock market movements tell us about underlying GDP in real time. We present a simple theoretical model to make key relationships clear, then explore US GDP and US stock market (S&P 500) performance through a range of analytical tools from visual inspection to correlations, regressions, counting and extreme value calculations to a few illustrative narrative investigations. We find that the S&P 500 is weakly correlated with real GDP as well as with vintage GDP releases contemporaneous, but more strongly and statistically significantly with one lag as theory predicts. We also find that the S&P 500 is more closely related both contemporaneously and with a lag to final, revised GDP numbers - only known months later - than to vintage GDP estimates, suggesting that stock market trends are informative about true GDP.