Use macro market analysis techniques to outline a portfolio construction plan. This should include the following:
1. Explore the relationship between the economy as measured by GDP and stock prices as measured by the S & P 500 post year 2000
2. Explore the general relationship of stock market, bond market, and interest rates
3. Discuss the historic impact of: a) inflation on interest rate b) inflation and interest rates on equity prices.
4. List 3 additional factors that affect security markets.
See the attachment for the full solution.
1. With the recent economic adversity, market participants and financial media have started focusing on gross domestic product (GDP) in deciding investment timing. Such participants wait for economic conditions to be more favorable which would increase the GDP and thus generate higher stock market returns. However, the research indicates that GDP has been a poor predictor of stock market returns. The relationship between annual changes in the GDP from 1929-2008 and corresponding stock market returns represented by S&P 500 is given below:
To find the relationship between GDP and S&P 500 returns, coefficient of determination was calculated. The coefficient is between 0 and 1, the closer the value to 1, stronger the relationship. The coefficient of determination, or the portion of stock market performance explained by GDP changes is only 0.1619, and the regression line is a poor fit. Hence, we can conclude that there is weak relationship between the economy as measured by the GDP and stock prices as measured by S&P 500.
The solution uses macro market analysis techniques to outline a portfolio construction plan.