A large part of the long-term variation in stock prices is due to unexplained factors instead of economic changes. Conversely, more than 99% of the movement in major bond prices is correlated with the economy’s movements.

These were the findings of an American Institute for Economic Research (AIER) study. The AIER sought to identify what long-term patterns, if any, were discernable between the movements of the economy and the financial markets.

Researchers with the organization used monthly growth rates for three bond indexes (U.S. government/credit, Treasury and corporate high-yield), three stock indexes (S&P 500, NASDAQ 100 and Russell 2000) and six economic variables (M2 money supply, ISM index of manufacturers’ prices, outstanding consumer credit, housing permits, initial jobless claims and average manufacturing workweek). Three cycles were considered: common (fluctuations shared between the economy, stocks and bonds), stock (fluctuations only shared by the stock indexes), bond (fluctuations only shared by the bond indexes) and business cycle (economic fluctuations with no connection to the financial markets).

Three unique factors were then used to explain each of the 12 variables: the common cycle, the group cycle (the stock cycle, bond cycle and the economic cycle) and the idiosyncratic cycle. The idiosyncratic cycle covered movements not explained by either the common cycle or the group cycle.

About 30% of the movement in the S&P 500 was attributable to the common cycle, while just over 1% of the movement in the Russell 2000 was. The stock cycle was linked to 51.5% of the movement in the Russell 2000, and 37% of both the S&P 500 and the NASDAQ. Idiosyncratic factors accounted for close to 50% of the movement in NASDAQ and Russell 2000 stocks and 32% of S&P 500 stocks. The authors say the large influence of idiosyncratic factors reflects the “individual variability of each stock index and the high uncertainty and high risk of investing in stocks.”

Nearly all (99%) government/corporate and Treasury bond variations are explained by the common cycle. This implies that economic fluctuations directly influence bond prices over the long term. High-yield bonds are less correlated, with the common cycle accounting for just 55% of the price variations.

Source: “A New Insight for Investors: How Financial Markets Interact With the Economy,” Jia Liu, Ph.D., AIER Issue Brief, June 29, 2015.