Daily Speculations

The Web Site of Victor Niederhoffer & Laurel Kenner

Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter;  a forum for us to use our meager abilities to make the world of specinvestments a better place.

 

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The Fed Model

The Chairman
Victor Niederhoffer

10/06/04
A 2004 Update on the Fed Model

Despite the hemming and hawing about the limitations of the Fed Model, which we have tested rigorously on a prospective basis, the main factor that determines whether stocks go up or down in a year is the differential between the forecast Earnings to Price ratio and the long term bond yield. Right now that differential stands nearly 2 % in favor of stocks. It's been above 1 percent as of the beginning of the year 6 times in the last 24 years, the average yearly change in the S&P those years has been 15.2%,  and the worst was up 2%. The main reason that the relation works in spite of rational expectations is that it's the key thing that pension funds, asset allocators, and individuals deciding between money markets and stocks are always interested in