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Share price models for selected S&P 500 companies

Avon Products share price model

Here we present a brand new share price model for Avon Products (NYSE: AVP). In April 2011, this model also showed a higher level of reliability and described the price through March 2011. We intentionally skipped it to publish in this blog because the predicted price showed just a small fall. The model was based on our concept linking share pieces and consumer price indices. The share price model for Avon Products was defined by the index of other household equipment and furnishing (OHEF) and that of public transportations (TPU). Figure 1 illustrates the evolution of these indices. In the April model, the former CPI component led the share price by 8 months and the latter one led by 5 months.

Here we revisit the model using the monthly closing prices (adjusted for splits and dividends) and CPIs for the period through September 2011. (The CPIs are available only for August 2011.) The principal result is that the underlying model is practically the same as six months ago with the same time lags but slightly different coefficients. This model predicted the fall in the price observed since June 2011 five months in advance.  The March and September models for AVP(t) are as follows:

AVP(t) =  -2.43OHEF(t-8) – 0.33TPU(t-5)  - 5.22(t-1990) + 392.49, March 2011

AVP(t) =  -2.25OHEF(t-8) – 0.33TPU(t-5)  - 4.58(t-1990) + 366.41, September 2011 

where AVP(t) is a share price in US dolalrs, t is calendar time. Relevant coefficients are both negative. The slope of time trend is also negative.  There is some fluctuation in all coefficients caused by the uncertainty in measurements of both the stock prices and CPIs.  Nevertheless, both models provide an accurate prediction at a five-month horizon as Figure 2 depicts.

Currently, the model shows  that the price has reached a stable level of $20 per share and will not be changing in the fourth quarter of 2011.  The predicted curve in Figure 2 (both versions are depicted) leads the observed price by 5 months with the residual error of $2.90 ($3.08 in April) for the period between July 2003 and September 2011. The model residual for the same period is shown in Figure 3.    

Figure 1. Evolution of the price of OHEF and TPU. 

Figure 2. Observed and predicted AVP share prices. Upper panel – March 2011; lower panel – September 2011.

Figure 3. Residual error of the model.

Beware of the BEA!

In our previous post, we mentioned a structural break in the Okun’s law around 1978. We explained this break by an artificial change in the definition of the GDP deflator (as defined by the Bureau of Economic Analysis) in the very same time, as also was described in this blog. Here we test quantitatively the change in the estimated Okun’s law coefficients as related to the introduction some new definition of GDP.

Figure 1 displays two time series – the consumer price index, CPI, and the gross domestic purchases price index, dGDP. These time series diverge since 1978 and thus the estimates of real GDP, which is nominal GDP reduced by the GDP deflator, are biased relative to the period before 1978. One should not use the real GDP time series as it is published by the BEA when modelling longer time series including years before and after 1978.

The CPI and dGDP curves coincide when the latter one is corrected by a factor of 1.2, as is also shown in Figure 1. Therefore, one must use the corrected GDP deflator when modelling a time series covering periods before and after 1978.

Figure 1. CPI, dGDP, and 1.2*dGDP.

We made a silly mistake in our study of Okun’s law when tried to use the estimates of real GDP published by the BEA and had to introduce an artificial structural break in order to fit both periods. The best-fit model (Okun’s law) minimizing the RMS error was as follows:

du = -0.406dlnG + 1.113, t<1979

du = -0.465dlnG + 0.866, t>1978

where du is the change in the rate of unemployment and dlnG in the change rate of real GDP per capita. All coefficients we estimated by a LSQ technique minimizing the overall model error. Figure 2 shows the predicted and observed rate of unemployment between 1950 and 2010.

Thus, the structural break expresses itself in a change of slope and intercept around 1978, this year was also estimated in the same LSQ procedure. The ratio of slopes is 1.15, i.e. very close to 1.2 obtained from the CPI and dGDP. Considering the uncertainty in both slopes in the above relationship, which is approximately 0.05, one can conclude that the break in 1978 is entirely artificial and our version of Okun’s law has no structural breaks whatsoever. Essentially, the predicted curve in Figure 2 could be obtained in one piece with a correct dGDP. One has to use the same definition of GDP before and after 1978.

Beware of the BEA! It is not a surprise that economists can not find any clear relationships between macroeconomic variables - they are wrongly measured and misrepresented.

Figure 2. Observed and predicted rate of unemployment in the US.

Some corrections to David Altig's job market charts

David Altig presented some projections of the unemployment rate based on various monthly increments in employment.  It was a crude estimate because it did not include inherent fluctuations in the growth of working age population and labor force participation rate. It is much better to use Okun’s law linking unemployment and the real GDP growth.

Previously in this blog, we presented a version of Okun’s law for the rate of unemployment in the USA since 1955 as defined by real GDP per capita. We have estimated Okun’s law coefficients in two different segments using a standard LSQ technique. The reason behind the split into two segments was the change in realGDP estimation procedure introduced around 1978 - the definition of the GDP deflator was dramatically changed. We discussed this important methodical issuein our blog.

The best-fit (dynamic) model minimizing the RMS error of the cumulative model is as follows:

du = -0.406dlnG + 1.113, t<1979

du = -0.465dlnG + 0.866, t>1978 

This model suggests a smaller shift in the slope and a larger change in the intercept around 1979. This Okun’s law is characterized by a standard error of 0.53% for the period between 1958 and 2010. The average rate of unemployment for the same period is 5.6% with an average annual increment of 1.06%.

            Using the relationship for the period after 1979, one can estimate the evolution of the unemployment rate for various growth rates o real GDP per capita. We have selected three different values: 1% per year, 1.86% per year, and 3% per year. The first value is approximately equal to the mean growth rate between 2000 and 2010 (11 years) which is 0.93% per year. The second value provides a constant rate of unemployment, as defined by the ratio of coefficients 0.866/0.465 and is slightly higher than the mean rate after 1980 (1.63% per year). The third value is very high and just demonstrates the condition to reduce the rate of unemployment to 4% by 2020.  Figure 1 depicts the predicted and observed rate of unemployment after 1980 and these three projections. This is a more accurate projection than that by David Altig.

I do not see any opportunity for the rate of unemployment to fall any time soon. In the long run, unemployment will remain high. For the slow growth scenario expected by the FRB, u may reach 13% by 2020.

 Figure 1. Observed, predicted and projected rate of unemployment in the USA.