# How macroeconomic factors affect stock returns

How macroeconomic factors affect stock returns

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examine how macroeconomic factors affect stock returns.
Order Instructions:
The goal of the project: We examine how macroeconomic factors affect stock returns.
Empirically, we can test the following model;
Rt= ?0 + ?1*Market Indext-1+ ?2*Inflationt-1+ ?3*GDP Growtht-1+ ?4*TERMt-1+ ?5*RISKt-1+?

1. Dependent variable: firms’ stock returns
I posted firms’ stock returns in three industries (air, auto, and computer) to Blackboard. You can analyze any firm as you wish. You can pick multiple firms from three different industries, or a single firm from a specific industry.

Variable Explanations
DATE: the end of trading date at each month
COMNAM: Company name
EXCHCD: Exchange code (1: NYSE, 2: AMEX, and 3:NASDAQ)
HSICCD: Industry classification (e.g., The SIC 4512 represents an airline industry.
PRC: Stock price at the end of each month’s trading date
RET: Stock returns at the end of each month’s trading date
SHROUT: shares outstanding
VWRETD: Market index
2. Independent variables: macroeconomic variables
* The Source of data: http://research.stlouisfed.org/fred2/tags/series
Download data as long as we believe that variables may affect stock returns.
There are some candidates for independent variables.
Market Index=VWRETD, and Firm Size= PRC*SHROUT
Inflation= log (CPIt / CPIt-1), and GDP Growth=log (GDPt / GDPt-1)
TERM= 10-year T/B – 3-month T/B, and RISK= BAAt – 10-year T/B?

Questions
1) Report summary statistics (n, mean, median, standard deviation, min, max) of your picked variables.
2)Why do you include such independent variables? Give me a brief explanation.
3) Run a regression and report coefficients and t-statistics for the explanatory variables.
4) Interpret coefficients of each variable. Compare it with your prediction
* To obtain full credit (20 points), you need to submit it by July 8th, 2014.Grade below 10 points will be counted as zero.
* The minimum requirement is 5 different firms and 5 independent variables.
* TERM and RISK should be included as independent variables.
* If you need a reference, please look at the paper written by Nai-Fu Chen, Richard Roll, and Stephen A. Ross. The title is “Economic Forces and the Stock Market (Journal of Business, 1986)”.

### How macroeconomic factors affect stock returns

Abstract

There are many macroeconomic factors that affect the stock market globally. Inflation and deflation have adverse financial effects on a company’s profitability which subsequently affect the stock market. The rate of increment on the prices of goods and other services constitutes inflation besides the increase in the cost of transportation and manufacturing expenses. (Swann, 2009) The stock market responds powerfully when the rate of inflation is low and weakens when it increases as most companies reduce their expenditures because of high cost of goods and services and the general money in economy reduces which results in reduced activities at the stock market. Deflation in most quarters is regarded as a sign of a weak economy as it also leads to a decrease in the stock market. (Chen, Roll and Ross, 1986)

The interest rates are established and monitored by Federal Reserve Board. Higher rates of interests are caused by the expensive nature of borrowing money. Money becomes too expensive to borrow. To subsidize their high rates of interests, most companies may opt to lay off workers and reduce expenditures on other goods. Higher rates of interests imply that even companies will not be comfortable when borrowing as the rate of interests becomes exorbitant and their income will also be affected. (Cairns, 2004) When the income of listed companies reduces then the investments in the stock market is also affected negatively.

1

 Sun Microsystems PRC RET SHROUT WRETD n 132 132 133 133 Mean 22.36021 0.001747 2447123 0.002766 Median 114.34 -0.08963 955344.5 -0.184 STD 34.098 0.16257 1201797 0.048607 Min 2.59 -0.39474 385583 -0.18462 Max 132.25 0.564103 3602000 0.110533 FRANKLIN ELCTRONIC PUBLISHS PRC RET SHROUT WRETD n 133 133 134 134 Mean 3.182147 0.013589 8063.91 0.003009 Median 9.445006 0.066578 8504.844 0.053974 STD 4.080006 0.21349 402.3438 0.053359 Min -3.845 -0.46429 7818 -0.18462 Max 11.9375 1.141434 8387 0.110533 SILICON GRAPHICS INC PRC RET SHROUT WRETD n 82 82 83 83 Mean 4.081159 0.025353 211362.6 0.003827 Median 14.69741 0.253384 439218.6 0.012599 STD 14.06612 0.521925 57156.86 0.041823 Min 0.44 -0.54676 182872 -0.10253 Max 20.5625 2.782609 268272 0.083911 APPLE COMPUTER INC PRC RET SHROUT WRETD n 96 96 96 96 Mean 43.137 0.035008 438980.5 0.004941 Median 63.01375 -0.03415 498318.5 0.024586 STD 30.86698 0.056931 511806 0.019459 Min 14.14 -0.57744 136417 -0.10253 Max 135.8125 0.453782 860220 0.083911 UAL CORP PRC RET SHROUT WRETD n 51 51 52 52 Mean 36.4751 -0.05963 56649.73 -0.00232 Median 62.25 0.042932 74327 0.060554 STD 43.42343 0.187492 32795.61 0.019813 Min 0.84 -0.51765 49792 -0.10253 Max 80.75 0.326258 99506 0.083911 FORD MOTOR CO PRC RET SHROUT WRETD n 144 144 144 144 Mean 17.04726 0.009958 1961721 0.004096 Median 39.11375 0.054011 2270481 0.053095 STD 31.57055 0.00097 1599931 0.02086 Min 16.79 0.053325 1139159 0.038345 Max 63.9375 1.273764 3401803 0.110533
1. Independent variables are included as they determine or influence other variables. An independent variable when manipulated determines or influences the change in the other dependent variable. This study seeks to determine if a relationship exists between the returns of the stock market and the macro economic factors that may affect the overall performance of the stock market.
2. Ford Motor Co
 SUMMARY OUTPUT Regression Statistics Multiple R 0.4995218 R Square 0.249522 Adjusted R Square 0.244237 Standard Error 0.148835 Observations 144 ANOVA df SS MS F Significance F Regression 1 1.04585 1.04585 47.213 1.849E-10 Residual 142 3.14556 0.02215 Total 143 4.19142 Coefficient Standard error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.0029 0.0124 0.2290 0.8192 -0.0218 0.0275 -0.0218 0.0275 VWRETD 1.7354 0.2526 6.8712 0.0000 1.2361 2.2347 1.2361 2.2347

Franklin Electronic Publish Inc

 SUMMARY OUTPUT Regression Statistics Multiple R 0.31 R Square 0.09 Adjusted R Square 0.09 Standard Error 0.23 Observations 133.00 ANOVA df SS MS F Sig F Regression 1 0.715 0.715 13.554 0.000 Residual 131 6.915 0.053 Total 132 7.631 Coeff Std Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.0094 0.019955 0.47106 0.6383832 -0.03 0.048876 -0.03008 0.048876 VWRETD 1.5147 0.411416 3.68157 0.0003377 0.7008 2.328532 0.700776 2.328532

UAL Corp

 SUMMARY OUTPUT Regression Statistics Multiple R 0.552 R Square 0.304 Adjusted R Square 0.290 Standard Error 0.156 Observations 51.000 ANOVA df SS MS F Sign f Regression 1 0.521 0.521 21.442 0.000 Residual 49 1.191 0.024 Total 50 1.712 Coeff Std error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.052 0.022 -2.372 0.022 -0.096 -0.008 -0.096 -0.008 VWRETD 1.933 0.418 4.631 0.000 1.094 2.772 1.094 2.772

Sun Microsystems

 Regression Statistics Multiple R 0.664 R Square 0.441 Adjusted  R Square 0.437 Standard Error 0.122 Observations 132.000 ANOVA df SS MS F Significance F Regression 1 1.527 1.527 102.6 3.92E-18 Residual 130 1.935 0.015 Total 131 3.462 Coeffici Std Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -0.005 0.011 -0.476 0.635 -0.026 0.016 -0.026 0.016 VWRETD 2.219 0.219 10.130 0.000 1.785 2.652 1.785 2.652

Silicon

 Regression Statistics Multiple R 0.260 R Square 0.067 Adjusted R Square 0.056 Standard Error 0.403 Observations 82.00 ANOVA df SS MS F Sig  F Regression 1 0.939 0.939 5.787 0.018 Residual 80 12.97 0.162 Total 81 13.91 Coe Std error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.017 0.045 0.391 0.697 -0.071 0.106 -0.071 0.106 VWRETD 2.338 0.972 2.406 0.018 0.404 4.272 0.404 4.272

1. Interpretation

Ford Motor Co.

The thesis of the study is to establish if a relationship exists between the performance of individual stocks belonging to different companies and the performance of the stock market and if the stock market can be affected by macroeconomic factors such as real GDP growth, inflation, interest rates or unemployment.

P-Value – 0.8192 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 1.7354 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.2495 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 24.95% of the stock returns.

Franklin Electronic Publish Inc

P-Value – 0.6383 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 1.514 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.09 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 9 % of the stock returns.

UAL Corp

P-Value – 0.022 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 1.933 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.304 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 30.4% of the stock returns.

Sun Microsystems

P-Value – 0.635 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 2.219 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.441 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 44.1% of the stock returns. (Draper & Smith, 1998)

Silicon

P-Value – 0.697 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 2.338 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.067 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 6.7% of the stock returns.

The Relationship Between RET and WRETD

My findings that are based on the graph above indicate that there is no relationship between the returns on the stock market and the general performance of the stock index. My predictions were that the relationship that exists between the stock market and the performance of the individual stocks is very limited.

Macro-Economic Analysis

USA Macro-Economic Indicators

The analysis from the above graphs indicate that there is a significant relationship between the returns on company stocks and the macro economic factors such as real GDP growth, unemployment level and inflation rate. When the macro-economic factors in the growing are positively improving then most company stocks post good returns. When the factors are negative, for instance when the rates of inflation and unemployment are so high then the stock returns also post low returns. In the year 2008, during the global economic crisis, most economies registered negative real GDP growth, the unemployment levels were so high and inflation rates were at their peak in most countries. The stock returns for most countries were also affected negatively and they registered a drop in their earnings. When inflation rates are so high most companies lay off workers to reduce expenses and decrease borrowings due to the high cost of borrowing while unemployment levels increases, the real GDP growth also decreases due to reduced circulation of money in the economy. (Swann, 2009)  The company stocks are calculated and classified as per its volatility and in accordance with the stock market risks and beta. During the economic crisis of 2008, the volatility of most stocks were at their highest together with the term of most bonds.

1. My investment strategy would be to invest as per the performance of the individual company stock and not the general performance of the stock market.

References

Cairns, J (2004). Interest Rate Models – An Introduction. Princeton University Press.

Chen, N., Roll, R. and Ross, S.A. (1986) Economic Forces and the Stock Market. Journal of Business.

Draper, N.R., Smith, H. (1998). Applied Regression Analysis (3rd Ed.). John Wiley.

Sullivan, Sheffrin, S (2003). Economics: Principles in action. Upper Saddle River, New Jersey

Pearson, Prentice Hall.

Swann, C. (2009) “GDP and the Economy – Advance Estimates for the Second Quarter of 2009,” Survey of Current Business, August 2009.

http://research.stlouisfed.org/fred2/tags/series?t=&pageID=9

http://research.stlouisfed.org/publications/iet

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