Stock market dispersion and business cycles

This article looks at another way to analyze stock price data that can help forecast business cycles. This kind of analysis is motivated by Black (1987, p. 113-114) who argued that the behavior of an industry's stock price can be used to forecast the industry's subsequent investment expenditures. Increases in an industry's stock price are generally followed by an increase in that industry's expenditures on plant and equipment. If stock prices are increasing in some industries but declining in others, it suggests that in subsequent years capital and labor will have to be reallocated from the contracting industries to the expanding ones. While beneficial in the long run, this reallocation of resources imposes short-run costs, that is, temporary declines in real activity as the resources move across industries. The greater the divergence in the fortunes of different industries, the more resources must be moved, and so the larger will be the resulting unemployment and fall in output.