Citigroup US Economic Surprise Index Is At Extremes

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One of the leading causes of unhappiness for my son is disappointment. It’s amazing how traumatizing even minor disappointments are in the eyes of a five-year old.

So, I’ve learned to manage his expectations.

For example, before we even set foot in a grocery store, I’ve already set the stage for a successful trip.  He knows if he doesn’t beg for every toy he sees, he gets a dollar's worth of quarters to spend in the gumball machines on the way out.

If I decide to buy him a toy while we’re at the store, he’s pleasantly surprised.  But if I don’t, he’s not disappointed.  No doubt about it, managing my son's expectations makes for a more pleasant shopping experience.

Believe it or not, the same is also true for investors…

Understanding how investor expectations can impact the market is key to investing successfully.  Simply put, when macro economic data is better than expectations, stocks tend to move higher.  And when economic data doesn’t meet expectations, stocks normally fall.

So, we can use the relative out/under-performance of macroeconomic data versus expectation as an indicator for the markets next move.

The good news is the Citigroup US Economic Surprise Index tracks all of the data for us.

When the index is in positive territory, economic data is better than expected.  When it’s negative, economic data is worse than expected.  A reading below -50 means we are missing expectations significantly.  And a reading above +50 means we’re beating expectations handily.

Here’s a Bloomberg chart of the index over the last year…


As you can see, the Economic Surprise Index has been volatile this year.

From December 2010 to March 2011, economic data was consistently beating expectations by a wide margin.  And stocks were also soaring higher as a result.

However, the index fell into negative territory this summer… meaning economic data was worse than expectations.  Not surprisingly, stocks had a horrible summer.

But it didn’t last long.  The index moved back into positive territory in October.  And like clockwork, the stock market began moving higher.

Clearly, there’s a strong correlation between stock prices and macro economic data.

Here’s the key…

Right now the Citigroup US Economic Surprise Index is at 49, the very high end of the range.  In other words, expectations have gotten ahead of economic reality.  This means disappointment is probably just around the corner.

Unfortunately, investors overreact to disappointment much like my five-year old son… And take it from me, that’s bad news for stocks.

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