A few key points:
- In the past, a negative CESI has led a decline in $SPX. In the first chart below, the yellow areas are where CESI turned negative since 2007. $SPX (blue line) followed each time, losing 8-10% or more each time. There was a two month lag in mid-2011 where $SPX stalled before a large correction.
- Part of this correlation relates to EPS revisions (second chart). JPM points out that when CESI heads lower, EPS estimates are typically revised lower. And vice versa.
- Another part of this correlation relates to valuation. When CESI heads lower, PE ratios typically also contract, and vice versa.
- A final component to this correlation is that bond yields move with macro expectations. When macro disappoints, yields head lower and bonds outperform equities (third and fourth charts).
- When CESI is -90 or lower, macro expectations have often bottomed (fifth chart).
CESI vs $SPX: the yellow areas are where CESI turned negative since 2007. $SPX (blue line) followed each time, losing 8-10% or more each time. Note also that global macro surprises are highly correlated with US macro surprises.
CESI vs EPS revisions: JPM points out that CESI (blue line) correlates well with EPS revisions. This chart is from August 2012. To wit, note that FY13 EPS consensus of $112 implies heady growth of more than 10% from FY12.
CESI vs forward PE ratios: In a prior post, we have have noted that there is a high correlation between CESI and valuation; when economic measures exceed expectations, multiples expand, and vice versa. See chart here.
CESI vs Treasury yields: Disappointing economic data (black line) leads to a decline in the treasury rates, and vice versa. The bond market knows.
CESI vs Equity/Bond relative performance: In summary, therefore, you would expect bonds to outperform equities (yellow line) when CESI (blue line) declines, and vice versa. And, in fact, that appears to be the case historically.