Effect of macroeconomic variables on stock returns under changing market conditions: evidence from the JSE sectors.
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Date
2020
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Abstract
The equity market is seen as one of the key determinants of the fraternity of finance, as it unites
investors with ambitions to invest in marketable instruments to earn a return on their
investments. The equity market not only unites investors with similar ambitions, but is an
important economic stimulus because it contributes a significant portion to economic growth.
Underlying financial theories illustrate an interaction between stock market returns and
macroeconomic variables. However, recently a debate has arisen in relation to the type of effect
that is evident between macroeconomic variables and stock market returns. This debate is
centred on the efficient market hypothesis (EMH), which depicts a linear effect and the
adaptive market hypothesis (AMH), which advocates for a nonlinear affect. Thus, there is no
empirical agreement regarding the relationship between macroeconomic variables and stock
market returns. In an attempt to contribute to the debate, the study examined the interaction
between macroeconomic variables and the Johannesburg Stock Exchange (JSE) indices returns
under changing market conditions. The study’s objective was to establish the effect between
macroeconomic variables and stock market returns in a bullish and a bearish market condition
and to compare the expected duration of each market condition among the selected JSE index
returns.
The study used the Markov regime-switching model of conditional mean with constant
transition probabilities. Moreover, preliminary tests in the form of graphical visualisations,
descriptive statistics, correlation tests, unit root tests and stationarity tests with and without
structural breaks were considered. The variables that formed part of the JSE consisted of the
real values associated with the JSE All-Share Index, Industrial Metals and Mining Index,
Consumer Goods 3000 Index, Consumer Services 5000 Index, Telecommunications 6000
Index, Financials 8000 Index and the Technologies 9000 Index. The macroeconomic variables
included the real values of inflation (CPI) rate, industrial production rate, short-term interest
rate, long-term interest rate, money supply (M2) and real effective exchange rate (REER). The
JSE index returns series and the macroeconomic variable series contained monthly data that
ranged from January 1996 to December 2018.
The findings of the regressed model illustrated the JSE All-Share Index returns are negatively
affected by long-term interest growth rate in a bull market condition, by short-term interest
growth rate in a bear market condition, and positively affected by industrial production growth
rate in a bear market condition. The Industrial Metal and Mining Index returns are negatively
affected by inflation growth rate in the bear market condition. The Consumable Goods Index
returns are positively influenced by growth rate of real effective exchange rate in a bullish
market condition, negatively affected by inflation growth rate, short-term interest growth rate
and growth rate of REER in a bear market condition. The Consumable Service Index returns
are negatively affected by short-term interest growth rate in a bull market condition and long-term
interest growth rate in a bear market condition. The Telecommunication Index returns are
negatively affected by long-term interest growth rate in the bull and bear market conditions
and positively affected by growth rate of REER in a bear market condition. The Financial Index
returns are negatively affected by long-term interest growth rate in a bull and bear market and
short-term interest growth rate in a bear market condition. The Technologies Index returns are
positively affected by growth rate of REER in a bull market condition. Moreover, the bull
market condition prevailed the longest across the JSE selected indices.
The findings of this study are consistent with AMH as it suggests that the efficiency and
inefficiency of equity markets are owing to changing market conditions. Hence,
macroeconomic variables affect the stock market returns differently under changing market
conditions. Moreover, the findings were seen to contradict EMH as it suggests equity markets
are efficient. As a result, the alternating efficiency effect under changing market conditions
suggests that the effect of macroeconomic variables on stock market returns is explained by
AMH and could be better modelled by nonlinear models. Thus, policymakers should consider
that the effect of macroeconomic variables on JSE index returns varies with regimes and,
therefore, develop appropriate policies.
Description
Masters Degree. University of KwaZulu-Natal, Durban.