Do Industries Lead The Market?

The title of this post comes from an article of the same name by Harrison Hong, Walter Torous, and Rossen Valkanov in the February 2009 Journal of Financial Economics (one of the top two or three academic finance journals). Their answer is "yes". Here's the abstract (emphasis mine):

We investigate whether the returns of industry portfolios predict stock market movements. In the US, a significant number of industry returns, including retail, services, commercial real estate, metal, and petroleum, forecast the stock market by up to two months. Moreover, the propensity of an industry to predict the market is correlated with its propensity to forecast various indicators of economic activity. The eight largest non-US stock markets show remarkably similar patterns. These findings suggest that stock markets react with a delay to information contained in industry returns about their fundamentals and that information diffuses only gradually across markets.

It's a bit heavy on the math for a typical undergrad or non-quant-jock, but well worth discussing in an investments class. My take on the article (at least as far as using it in the classroom) is that it provides pretty interesting evidence that economic fundamentals matter, and that markets are forward looking. Yeah, I know - these aren't new findings. But since I'm teaching CFA, I've been talking a lot about "fundamentals" (it's a big emphasis in the program). So it's been on my mind.