Ignore the Fed Factoid
The insightful investor is skeptical of factoids.
And for good reason!
If you want to use history as a guide, care is required. I thought this was pretty obvious until my morning watching of CNBC in Davos (it doesn’t seem the same without Maria) showed Andrew Ross Sorkin interviewing Kenneth Rogoff. This seemed interesting, so I turned off the mute button and backed up the TIVO. Here was someone who could really grill Rogoff about the research findings that are now the source of so much controversy.
What a disappointment! There were no hard-hitting questions. Even worse, Sorkin uncritically accepted as fact a silly bearish idea about the Fed. CNBC has trimmed the interview to exclude that portion, but I have it on TIVO. Sorkin says that whenever there is a new Fed Chair, the market corrects within the next six months.
Let us examine that Factoid.
Background
A couple of weeks ago a Famous Bearish Pundit noted on Twitter than when there was a change in the Fed Chair, the market usually declined. Someone asked the FBP when he expected the correction. He replied that it was not a prediction, it was a fact.
Well!
There is a lot of buzz about not doing predictions, but most of the history cited is offered with that in mind. The basic notion is that history will repeat, and that these simple bivariate relationships are relevant to your trading or investing.
FBP moved on, but here is a source that took up the argument.
The average maximum drawdown in stocks during the first six months of a new Fed Chairman has been 16%. This is consistent with other indicators that suggest an elevated risk of correction as we move through 2014.
Analyzing a Factoid – First Cut
Whenever you are presented with a proposition like this, the insightful investor should be seeking a basis for comparison. Suppose for example, that the maximum drawdown for stocks is ALWAYS 16% over the next six months. In my own work, I always warn investors that this level of change is a normal fluctuation, having nothing to do with the fundamentals of the market. What you really need is a 2 by 2 table, with Fed leadership change and No Fed leadership change on the horizontal axis, traditionally reserved for the independent variable. Then we can see if there is a real difference in results. Should it be average result? Maximum drawdown? What time period?
You can be sure that your pundit will pick the case that favors his viewpoint.
Second Cut
The insightful investor digs a little deeper. I always look at the data. Statistical experts regard this as getting your hands dirtyJ Instead of blindly accepting a statement about changes in the Fed Chair, you ask what data might be relevant. Let us start by looking at the history of changes, from Wikipedia.
| # |
Years in office |
President(s) with whom they served[9] |
|
| 1 |  Charles S. Hamlin |
August 10, 1914 – |
|
| 2 |  William P. G. Harding |
August 10, 1916 – |
|
| 3 |  Daniel R. Crissinger |
May 1, 1923 – |
|
| 4 |  Roy A. Young |
October 4, 1927 – |
|
| 5 |  Eugene Meyer |
September 16, 1930 – |
|
| 6 | Eugene R. Black |
May 19, 1933 – |
|
| 7 |  Marriner S. Eccles |
November 15, 1934 – |
|
| 8 | Thomas B. McCabe |
April 15, 1948 – |
|
| 9 |  William McChesney Martin, Jr. |
April 2, 1951 – |
Harry S. Truman |
| 10 |  Arthur F. Burns |
February 1, 1970 – |
|
| 11 |  G. William Miller |
March 8, 1978 – |
|
| 12 |  Paul A. Volcker |
August 6, 1979 – |
|
| 13 |  Alan Greenspan |
August 11, 1987 – |
|
| 14 |  Ben Bernanke |
February 1, 2006 – |
|
| 15 |  Janet Yellen |
February 1, 2014 – |
Does anyone really think that the depression-era results are meaningful?
It should be obvious that most of this history is totally irrelevant – at least through 1970. Arthur Burns came in to deal with inflation, and it is natural for this to have a negative market effect. Miller had a brief and unhappy tenure. Volcker had a mission like that of Burns. Greenspan came in right before the 1987 crash, which had nothing to do with the change in the Fed Chair.
Any open-minded person who looks at this history should realize that the change in Fed Chair has little to do with stock market prospects.
And to Emphasize
If there were ever an occasion when it made no difference at all, this would be the time. Yellen has been Vice-Chair, supportive of all policies, and pledged to continuation. Bernanke clone is sometimes mentioned, although I personally expect her to show some independence.
Investment Conclusion
My final words will be familiar to regular readers. There is a vast disparity between what is popular in the media and what will help your investments. Popular sources are rewarded for page views and ratings. The average investor is not watching, so the ratings come from a different source.
Of course there could be a market correction – something that pseudo-experts were calling for with assorted messages during all of last year. We will probably see one during 2014. It will have absolutely nothing to do with the transition in the Fed.
The insightful investor knows better!
I have looked closely at the facts since 1950 – obviously there are different market situations, but the data is pretty compelling….
The bottom line is that there definitely is some truth to the view that the market always provides a test to the incoming Chair of the Fed. The question is when…. and it is later than the bearish pundits would like to think….
The data show two key points:
1) There is an initial rally when the Fed Chair takes over at the start of their term
2) There is then an initial correction. If the initial correction is less than 13%, then there will be a continued substantial rally and then an even BIGGER correction.
Looking at the initial rally.
• The median length is 56 days with a 6.9% price change
• The longest was 189 days under William Miller in 1978 as the market came out of its 27% 14 month correction that ended 5 days before he started.
• The shortest was 14 days and 2% as the market topped out on the Tuesday post opex in August 1987 just two weeks after Alan Greenspan started
With respect to the initial corrections, they were remarkably similar in length
• With the median being 56 days. The longest being 64 days and the shortest being the Bernanke 33 day correction.
• As the size of the initial corrections is so dramatically different, let me list them:
o William McChesney Martin
-8.8% in 56 days
o Arthur Burns
-21.9% in 62 days
o G. William Miller
-15.0% in 64 days
o Paul Volcker
-12.4% in 33 days
o Alan Greenspan
-41.2% in 56 days
o Ben Bernanke
-9.0% in 33 days
With respect to the even bigger eventual corrections, these were experienced under Martin, Volker and Bernanke, but before those corrections occurred, there were substantial rallies.
• Martin
o Rally: 19.4% over 644 days
o Correction: -13.9% in 253 days
• Volker
o Rally: 8.1% in 191 days
o Correction: -20.5% in 43 days
• Bernanke
o Rally: 30.4% in 617 days
o Correction: -54.7% in 512 days
Always enjoy your blog.
THANKS!
-D