Young Research & Publishing Inc.

Investment Research Since 1978

  • About Us
    • Contributors
    • Archives
    • The Final Richard C. Young’s Intelligence Report
    • You’ve Read The Last Issue of Intelligence Report, Now What?
    • Dick Young’s Research Key: Anecdotal Evidence Gathering
    • Crisis at Vanguard
  • Investing Analysis
    • The Efficient Frontier
    • Bonds
    • Commodities
    • Currencies and Gold
    • Dividend Investing
    • Economy
    • ETFs & Funds
    • Investment Strategy
    • Real Estate
    • Retirement Investing
    • Stocks
    • Taxes
    • Facebook
  • Money Management
  • Dynamic Maximizers®
  • Retirement Compounders®
  • Free Email Signup

The Great Enabler of Stock Market Bubbles

March 23, 2016 By Jeremy Jones, CFA

GMO’s James Montier and Philip Pilkington have a nice piece up on the vast distortion that Fed policy has created in equity prices over recent decades. According to the researchers, it may not be the ultra-low rates that have created such lofty asset prices, but the Fed’s willingness to step in at every market hiccup to prevent greater fallout that has led to the distortion.

Some of the highlights are below. The full  piece can be read here.

…But, from 1985 onwards, removing fewer days began to have a major and increasing impact on the market. In fact, FOMC days account for 25% of the total real returns we have witnessed since 1984!

One of our bright young colleagues,2 who is considerably more statistically sophisticated than we, calculated that the chance of this occurring randomly was only 0.0086% (that is, 86 out of 1 million). As he put it, “The odds are astoundingly low!”

The Monetary Policy-Adjusted CAPE

We can use this insight to build a counter-factual picture of the world: a measure of the S&P 500’s valuation if the Fed didn’t have any impact on the animal spirits of investors. We simply take the return series for the S&P 500 and replace the days when the FOMC met with the average return on non-FOMC days (using an expanding window) and use this to then calculate the Monetary Policy-Adjusted CAPE. Exhibit 6 plots the standard CAPE and our adjusted series.

If we remove the impact of FOMC days, the CAPE looks to be significantly more mean reverting than  it has over the last 20 years or so. The adjusted CAPE fits with our intution over this period: The tech bubble would not have gotten quite so big (although it would still have been the biggest stock market bubble in U.S. history) without the Fed’s help; in the wake of the GFC the market would probably have gotten down to the levels of valuation associated with a serious crisis (i.e., single-digit P/Es). Thus, if we believe this data we can say that post the GFC in particular the Fed has impacted the valuation of the stock market
significantly, preventing mean reversion to occur in the fashion that we would have expected.

…Betting on the Fed’s ability to generate continued market levitation seems like a dangerous game to us, but as Newton long ago opined, “I can calculate the motion of heavenly bodies, but not the madness of people.”

 

The following two tabs change content below.
  • Bio
  • Latest Posts
My Twitter profileMy LinkedIn profile

Jeremy Jones, CFA

Jeremy Jones, CFA is the Director of Research at Young Research & Publishing Inc., and the Chief Investment Officer at Richard C. Young & Co., Ltd. Jeremy is a contributing editor of youngresearch.com.
My Twitter profileMy LinkedIn profile

Latest posts by Jeremy Jones, CFA (see all)

  • After Long Declines, Branded Consumer Companies Comfortable Raising Prices - February 15, 2019
  • Can You Rely on Income Funds? - February 14, 2019
  • Brazil’s Finance Minister Defends its ‘Vibrant Democracy’ - February 13, 2019

Related Posts

Our Most Popular Posts

  • Your Retirement Life: What States Did Americans Flee in 2018? Where Did They Go?
  • When You Get OLD, Things Have to Be RIGHT
  • The Power of a Compound Interest Table
  • Morgan Stanley Calls an "Earnings Recession"
  • Build Your Investment Strategy for the Field of Play
  • Americans Most Optimistic in 16 Years About Their Finances
  • Can America Afford the Green New Deal?
  • Bank Bulk Up: BB&T Buys SunTrust
  • The Dynamic Maximizers® Solution
Fidelity: #1 Online Broker

The Global Bear Market

American Factories Booming

Is This Just the Beginning of the FAANG Collapse?

My Concentration Is on Full Faith & Credit Pledge U.S. Treasuries

This is What Can Happen When You Invest Without a Margin of Safety?

Search Young Research

RSS The Latest at Richardcyoung.com

  • Immigration, the Unifying Force of Europe’s Right Wing
  • Republicans “Sabotaging” Green New Deal?
  • Do You Have What it Takes to be a Great One?
  • Minnesota Muslim Rep. Omar Off the Rails Again
  • “Liberty Has Been Supplanted by Diversity,” Justice by Equality
  • What Are You Getting Paid?
  • Tucker Explains: Donald Trump: “We Have Destabilized the Middle East”
  • 751 “No-Go” Zones in France
  • Brigades of Citizens to Diaper Flatulent Cows?
  • Hungarian Hardliner Viktor Orban Shows European Globalists the Way

About Us

  • About Young Research
  • Archives
  • Contributors

Our Partners

  • Richard C. Young & Co.
  • Richardcyoung.com

Social Media

  • Facebook
  • Twitter
  • Youtube
  • Pinterest

Copyright © 2019 | Terms & Conditions