A recent paper by the University of Chicago Booth School of Business professor George M. Constantinides and McGill University’s Anisha Ghosh, “What Information Drives Asset Prices?” offers some insights. One is that the Consumer Price Index and average hourly earnings provide better guidance about the direction of the market than does consumption spending alone. In other words, Keynes was wrong.
But the best insight is that the phase of the business cycle we are in offers the best advice on the market’s future. The authors call the phases “regimes” and use just two, expansion or recession.
The consumption and dividend growth rates have higher means in the first regime than in the second one. Therefore we identify the first regime as the regime of economic expansion, with a higher mean of consumption and dividend growth rates and longer duration than the second regime...In other words, the investor is able to effectively forecast the regime in the next period...”So the investors who accurately guess whether the next period will usher in a recession or continue the expansion will do better at predicting the market. The authors of the paper assume that investors use a range of macroeconomic variables, including Consumer Price Index and average hourly earnings, to guess what regime or phase of the cycle comes next.