Part II: Macroeconomic Shocks and Stock Prices
VICTORA. CANTO AND ARTHUR B. LAFFER
Over the past decade, research at A. B. Laffer Associates has focused on measuring the effects of macroeconomic shocks on specific industry stock returns. Our CATS (Capital Assets Tax Sensitivity) strategy predicts the relative performances of individual industry stocks in the aftermath of these economic shocks. 1
The CATS strategy classifies industry groups into High-CATS and Low-CATS categories. This classification is based primarily on how stocks performed following tax rate reductions in the 1960s. 2 Stocks which performed best when tax rates were low and falling are designated as High-CATS. In contrast, Low-CATS industry groups are those which performed poorly, on a relative basis, when tax rates were low and falling. It follows that Low-CATS stocks tend to outperform High-CATS stocks (and the market) during periods when tax rates and other production disincentives are increased.
The specific criterion used for the High-CATS/Low-CATS border was whether the industry's stock return outperformed the S&P 500 index during the base period 1962-66. These five years were selected because they encompass the trough to the peak of the bull market which followed the Kennedy income tax rate reductions. 3 Depending upon the individual industry's stock performance during 1962-66, the industry received a CATS classification of either High-