Sunday, July 08, 2007

Interest Rate Intuition / Hussman On The "Fed Model"

Excellent anti spin from Hussman. Keep this in mind when the "eyperts" try to spin bad economic news into gold (lower yields, higher stock prices) . Hussman shows that this is in the longe term just bubbletalk. But i have the feeling that long term is today often viewed until the next jobs report, the next cpi number etc...... Click on the headline to read the entire report
Großartiger Bericht zu dem oft zitierten "Fed Model" von Hussman. Man sollte die "Experten" nicht für voll nehmen wenn Sie dieses Argument undifferenziert bringen. Das passiert immer dann wenn schlechte Daten in positive für die Börsen umgedeutet werden (niedrige Renditen, steigende Aktienkurse). Hussman zeigt sehr schön das dieses Argument langfristig aus dem Reich der Fabel stammt. Da ich aber eh immer mehr das Gefühl habe das langfristig heutzutage (speziell in den USA) häufig nur bis zum nächsten Arbeitsmarktbericht, der nächsten Fed Sitzung etc bedeutet....... Klickt bitte auf die Überschrift um den kompletten Bericht zu lesen
It continues to fascinate me that investors are entirely willing to base their financial security on concepts that can be wholly disproved with even a cursory look at historical data. The Fed Model is the predominant example of this at present. The following chart should be sufficient to reiterate that the effect of interest rates on stock valuations is vastly overrated, and that raw earnings yields (particularly based on peak earnings to date) explain subsequent market returns far better than indicators that “adjust” for interest rates in the way the Fed Model does.

The truth is that the relationship between stocks and interest rates is far more nuanced than the Fed Model assumes.

Since 1950, the average yield on the 10-year Treasury bond has been just below 6%, while the average price/peak earnings multiple on the S&P 500 has been slightly over 14. For simplicity, we'll use those levels to define bond yields as “low” or “high” and to define stock valuations as “cheap” or “expensive” relative to long historical averages. Also for simplicity, we'll classify interest rates as “falling” when the 10-year Treasury yield is below its level of 6 months earlier, and “rising” otherwise.

Our intuition should immediately suggest that stocks probably perform best when valuations are cheap and interest rates are both low and falling. We should also expect that such favorable conditions would not have been observed too often. As it happens, that intuition is correct. That combination of conditions has historically occurred only about 7% of the time, but during those periods, the S&P 500 has achieved average annualized returns of 31.72%.

In contrast, our intuition should suggest that stocks probably perform worst when valuations are expensive and interest rates are both high and rising. Again, that intuition is correct. Such a combination of conditions has historically occurred about 10% of the time, and during those periods, the S&P 500 has achieved average annualized returns of 3.05%, clearly below Treasury bill yields, and generally with a great deal of volatility as well. When interest rates have been high and rising, the total return on the S&P 500 has been muted at about 4.00% annualized even when stocks have been relatively cheap.

Low interest rates are no panacea
Beyond those conditions, however, the intuition of the typical investor is likely to be badly off the mark. The reason is that investors have come to believe that low interest rates are a good thing for stocks in general, when in fact they are only a good thing if stock valuations are cheap. Importantly, low interest rates are of no help to stocks when stock valuations are rich. Contrary to the bad intuition that the Fed Model instills in the minds of investors, relatively low interest rates (at least on the basis of 10-year bond yields) are not nearly sufficient to justify or offset the negative effect of rich stock valuations. ....

In general, high stock valuations coupled with low interest rates (as we have now) have historically been symptomatic of a fully priced, overly optimistic market, with little margin for error.

With stock valuations rich, interest rates still relatively low but clearly rising, just 18% of investment advisors bearish, and short-term trends overbought, my hope is that investors do not allow the excitement (or frustration) of a market near new highs to obscure the very real danger here for long-term investors.


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3 Comments:

Anonymous Anonymous said...

Hard to argue with what he says -- he makes a good argument that aligns well with common sense too.

Aber, his funds are striclty für oma.

eh

1:51 AM  
Blogger jmf said...

Moin,

must be sometimes for him frustrating to watch the insane market action these days.

But i think everybody that invest money in one of his funds knows exactly what he is getting.

And i think they will outperform the overall indices very soon by a wide margin :-)

2:01 AM  
Anonymous Anonymous said...

And i think they will outperform the overall indices very soon by a wide margin :-)

Aber, nach meine Meinung...

This is one of the benefits of the upsurge in fund and ETF offerings: if you really believe that, then there are now some good ways to put that opinion to work in the markets via a short position, including in accounts where it is verboten to take traditional short positions (IRA accounts in the US, zum Beispiel). Sogar mit leverage.

This page is a good place to start getting ideas about that.

eh

3:29 AM  

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