The Yardeni Fundamental Stock Market Indicator

The great strategist Ed Yardeni has devised an index that he calls the “Fundamental Stock Market Indicator.” It is defined as the _Average of Consumer Comfort Index and his Boom-Bust Barometer, which is the CRB raw industrials spot index divided by the four week moving average of initial employment claims._ Sounds a little too complicated to work, right? That’s what I thought. So a couple of years ago, I decided to model up his indicator and continue to track it. And what do you know – it actually works quite well at tracking the S&P 500. There are divergences that seem to be portend the end of its usefulness, but then out of nowhere the stock market either corrects or rallies to bring the correlation back in line. Yardeni’s “Fundamental Stock Market Indicator” is a surprisingly great model. Here is the chart I created with the formulas Yardeni provided: 500 in orange and Yardeni indicator in white</a>


So if in the future this model continues its predictive nature, then what does it mean for the market?

To figure that out , let’s go through the different components one by one. First up is the ABC News US Weekly Comfort Index. According to Bloomberg this index is “ a four-week rolling average based on telephone interviews with about 1,000 adults nationwide each month. The negative responses to each question (state of the economy, personal finances and buying climate) is subtracted from the positive responses.”

Let’s have a look at how this index has behaved versus the S&P 500 for the last decade: Comfort Index (white line) vs S&P 500 (orange line)</a> </div>

Although it did loosely track in the beginning to the mid 2000’s, for the past 5 years it has gone sideways while the S&P 500 has gone straight up.

So that variable does not explain the Yardeni’s Fundamental Stock Indicator’s recent predictive power, so let’s examine the other half of the equation.

The “Boom-Bust” indicator is defined as the CRB raw industrials spot index divided by the four week moving average of initial employment claims. How does it stack up versus the S&P 500? (white line) vs S&P 500 (orange line)</a> </div>

This part of the equation obviously explains a lot more as the correlation during the past few years is very close. The Boom-Bust was a little ahead of the stock market during 2010–2011, but since then the S&P has played catch up.

Let’s have a look at the two parts of this Boom-Bust indicator separately. First the numerator – the CRB Raw Industrials Index: Raw Industrials Spot Price</a> </div>

This index hasn’t moved all that much during the past few years, so this isn’t the answer to what makes the Yardeni Indicator track the market so well.

Now let’s move over to the denominator. The Four Week moving average of initial jobless claims has certainly being moving lower: week average of Initial Jobless claims</a> </div>

This part of the equation is obviously the big driver during the last couple of years. This is obvious when you plot the S&P versus the inverted jobless claims: Jobless Claims (white line) vs S&P (orange line)</a> </div>

So what can we draw from all of this?

Most of the recent gains from the “Fundamental Stock Market Indicator” can be attributed to the vast improvement in the Initial Jobless claims. Yet herein lies a problem. It was probably a lot easier to go from 500k to 300k initial jobless claims than it will be to go from 300k to 100k. So if you are bullish on the equity market, you probably shouldn’t be counting too heavily on this portion of the indicator continuing to do the heavy lifting.

Which means that if this indicator is going to continue to be predictive and you want the stock market to rise, either the ABC Consumer Confidence number is going to have awake from the dead, or the CRB Raw Industrial Index is going to take off.

So according to this model, for the next leg of this bull market to really gain traction you will need industrial commodities rising, along with consumer confidence all the while jobs continue to improve (or at least not deteriorate).

It also shows that absent a material decline in some combination of these three indicators, the Yardeni Fundamental Stock Model is not calling for a meaningful correction in the stock market.

The market is obviously much more complicated than simply throwing three economic variables together and coming up with a forecast. Yet you have to give this model credit for being much more robust than it appears at first glance.

It is also helpful to understand what has been driving it over the past few years, and what part of the equation needs to take over for the index to move on to new highs.

And finally, in this period of hedge fund liquidation, it is helpful to remember that indicators like the Yardeni Fundament Stock Market Indicator are not screaming crash. It doesn’t mean we can’t go lower, but it probably won’t be as bad as the new found bearish hedge funds believe.