New study: The connection between business cycles and the stock market in Israel
- The study found that the industrial stock index precedes the turning points in the Industrial Production index by an average of 7 months with a standard deviation of 3 months.
- The study was carried out as part of a project to develop Composite Leading Indicators (CLI) for the level of economic activity in the economy.
- The results obtained in the study enable a chronological determination of business cycles and constitute an additional tool for the central bank to make short term forecasts of turning points in economic activity.
Forecasting "business cycles" has great importance for fiscal and monetary decision makers in the economy, for the business sector, for investors, and for households, since it enables them to adjust their economic plans in a timely manner. Of particular importance is the forecasting of turning points from economic growth to situations of slowdowns and vice versa. The study—carried out by Ariel Mantzura and Dr. Benzi Schreiber of the Bank of Israel's Information and Statistics Department—assessed the differentials in timing between turning points in the Tel Aviv Stock Market and turning points in a number of macroeconomic series that represent the level of activity in the Israeli economy. The turning points in the capital market and in the level of economic activity were identified with the use of Markov Switching Models (MSM), enabling them to clearly distinguish between growth and slowdown situations.
The motivation for using capital market data for the purpose of forecasting turning points in the economy derives from the fact that the level of economic activity is connected to developments in the capital market, through two main channels: (1) In an efficient market, stock market prices contain all of the existing information regarding companies' future economic situation; (2) Price levels and volatility in the stock market influence the public's sense of wealth, thereby affecting the level of economic activity in the economy through private consumption.
The aim of the study was to assess whether it is possible to forecast turning points in business cycles, particularly in the short term (up to one year), using the stock market indices. The target variable selected for this purpose is the Industrial Production Index. This target variable is an alternative to Gross Domestic Product in many market models, including in the OECD countries, particularly models that use monthly data and are intended to provide forecasts at that frequency.