After the Fed – Adding to the Ned Davis Story
There is a difference between a compilation of data and research. Several recent "studies" of market behavior after the Fed finishes tightening have listed the stock market returns in the subsequent period. Despite some rather obvious weaknesses that we have described in a prior discussion, these reports continue to get a lot of play in the financial media.
Institutional investors pay a lot of money for research like this, and one assumes that they have staff that can help them with the interpretation. When the studies get so much play in the media, however, it starts to have an impact on my own clients. They depend upon me to follow this work and assess the validity. That is my mission here.
I have added some information (some from the Federal Reserve Board’s official site, and some calculated, adding 1971 which was left out by Davis) to illustrate the various ways one might interpret the compilation.
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There is little to be learned from this compilation. There are too many different variables and not enough cases. I wish that the next journalist who runs a story about the "Ned Davis findings" would ask them why they thought the depression era changes were relevant. The Fed does not even include these in their database. They only show the ending dates, so you do not see that the 1953 cycle took seven years to increase the discount rate from one percent to two percent. Who cares? Does anyone really believe that these changes have anything to do with market prospects after this tightening cycle?
You could look at the data here and try to consider the length of the cycle, the amount of the increase, the starting or ending rate, or many other factors. If you feel compelled to draw an inference from similar cases, why not look at the results since the creation of econometic modeling. Since I was working in this field in 1976, I can put a nice starting point on the analysis! All of a sudden the conclusion is much different, a normal positive result.
I addressed the lack of similarity in Fed tightenings in this post, and also in my discussion of Ed Keon’s excellent work. Ed pointed out that the key factor in the Fed cycle was whether or not they were successful — not any "average" analysis. I am sure that a good quantitative guy like Ed was not putting too fine a point on this. Any multivariate analysis requires plenty of data. But his conclusion is excellent.
Investors would be wise to ignore all of these pseudo relationships and look to the market fundamentals. As we will show in upcoming posts, there is a lot of negativity "baked in" to current pricing, partly because of the widespread publicity and acceptance of reports like that from Ned Davis.