On the Fed and Markets; Vegetarian Diets, Global Health and the Environment!

From: aditya rana
Date: Sat, Mar 26, 2016 at 1:40 PM
Subject: On the Fed and Markets; Vegetarian Diets, Global Health and the Environment!


The positive impact of the Fed’s QE policy on asset prices has been clear in the aftermath of 2008 financial crisis, but what is still subject to debate are the mechanisms by which QE translates into higher asset prices. While the lowering of interest rates through QE is seen to be the obvious explanation, could there be other transmission mechanisms at play here? James Montier, an “out-of-the-box” analyst at the value firm GMO, tries to quantify the impact of the Fed actions on the US stock market and draws some surprising conclusions. (https://www.gmo.com) To summarise:

-“Crying over spilt milk” in context of analyzing past errors with the objective of improving their understanding of markets is a core principle at GMO, and they had a closer look at the possible reasons behind their overly pessimistic forecasts for the S&P 500 over the past two decades.

-Based on prior work (see chart below which represents the contribution of three sources to the forecast errors – fundamentals, P/E and margins), they have found that their valuation framework has tended to underestimate market returns as the market has continued to be more expensive (in terms of P/E) , and it does not seem to have been so due to low interest rates.

-Searching for other reasons behind this phenomenon, a Fed paper in 2013 analysed the impact of Fed meetings on the stock market (via tick data around FOMC meetings) and found that the market pre-FOMC meeting returns have increased over time and now account for a sizeable portion of total annual returns. They also concluded that the excess returns were not due to the markets “pricing” in Fed decisions but the actual impact of the Fed decisions on the markets.

-They reached a similar result using full-day data and concluded that the Fed has had a big impact

on market behavior. Plotting the S&P 500 versus the index excluding the FOMC meetings days (see first chart below) and the relative cumulative impact of an investment strategy involving being long the market only on the FOMC days (see second chart below) clearly illustrate this remarkable phenomenon, which commenced around 1985 and has had an increasing impact since then.

-The impact of Fed meetings was non-existent from 1960 until 1983, but since 1985 there was a clear and increasing impact of Fed meetings (which were actually fewer in number – 8 days a year – than during the previous period), and have accounted for 25% of the total returns since then.

-Analyzing the data further (see chart below) they make some observations: the average returns on FOMC days across a variety of time periods shows that the period 2008-2012 was exceptional with the average daily return being 29x higher than on the average day, highlighting the substantial impact of the Fed’s QE policies, but more recently the impact has gone back to post 1980s levels.

-One possible explanation for this phenomenon could be that the Fed has been in an easing trend over the period. Breaking down the data from 1990 (when the Fed became very explicit about their policy actions) into days when the Fed increased, decreased or left rates unchanged (see chart below), they find that there is no statistical difference in the returns between the days when rates were increased or cut (even including two big easing days in 2008). It appears that the market reacts well to a Fed meeting without consideration to the specific policy action?

-Analysing the impact of this phenomenon on valuations but adjusting the Shiller CAPE return series by replacing the returns on FOMC days with the average non-FOMC days they derive a Monetary Policy – Adjusted CAPE (see chart below). Comparing this series with the normal series (to highlight the impact of the FED) shows the mean-reverting nature of CAPE over the past two decades, the tech bubble not getting quite as large, and the market correcting more meaningfully (i.e. to single digit levels) subsequent to the 2008 financial crisis – just as their valuation models would have predicted.

-The key question is whether the Fed would continue to have a similar impact going forward – with the bulls arguing that a Greenspan/Bernanke/Yellen put results in a higher P/E compared to historical averages while the bears making the case for a crash to correct the artificially overvalued markets.

-Absolutely fascinating analysis which underscores the theme of these newsletters ever since 2010 (post QE2) – that Fed (and other central banks) policies will continue to be the main driving factor behind market returns over the next few years. While the Fed has embarked on a tightening cycle from last December, a Yellen-led Fed will balk at the first sign of market turmoil as evidenced at the recent meeting. Therefore, I cannot envisage a serious market correction (20% plus) under Yellen’s term which ends in 2018 and more likely a move well into bubble valuation territory (2,250 on the S&P) as expected by Jeremy Grantham from GMO. Subsequently, the risks of a serious crash would increase significantly – particularly if the Fed will then be constrained by an active “political campaign of fear” (we can already see clear signs of that now!) as highlighted by the great economist Irving Fisher in his classic 1933 paper on depressions.

-This has been the most remarkable, central-bank supported rally of risk assets in history, with the S&P rising some 200% to hit all time highs around 2,100 just one year ago, and restoring $14 trillion to stock values. The move since March 9, 2009 is now the third longest bull market in history, and just days away from being the second longest rally on record and likely to eventually become the longest bull market in history.

-Maintaining a globally diversified asset portfolio, with a tilt towards emerging markets, continues to offer the best expected return. As investment advisor Larry Swedroe says, “The key to being a successful investor isn’t, as Wall Street and much of the financial media would like you to believe, about being able to accurately forecast which asset will do well when. Instead, it’s about remaining disciplined and adhering to your asset allocation plan. That means having the courage to rebalance to your target allocations, buying what has done poorly and selling what has done well—and that’s something a lot of investors are unable to do on their own.”

-Christopher Brightman, chief investment officer at Research Affiliates, observed that the cyclically adjusted price-to-earnings ratio for EM fell to 10 in January. He further noted that there have been only six times when the measure has dipped below 10 over the past 25 years. In the following five years, the stocks rallied an average 188%. Brightman then made the following important observation: “From the rear view mirror, the bear market in emerging markets has been painful. When we look out of the windshield, however, these very asset classes offer the highest potential returns available.”

Vegetarian Diets Best for the Environment and Human Health:

Interesting research which highlights the importance of a plant-based diet on both health and the environment in terms of quantifying the potential impact over the next few decades:

PRCM, March 24, 2016:

Springmann M, Godfray HCJ, Rayner M, Scarborough P. Analysis and valuation of the health and climate change cobenefits of dietary change. Proc Natl Acad Sci U S A. Published online March 21, 2016.


-Vegetarian and vegan diets are best for the environment and human health, according to research published online in the Proceedings of the National Academy of Sciences of the United States of America. Researchers assessed several regional models that incorporated environmental, economic, and health impacts associated with a dietary change in the future. Diets compared included proportional reduction in animal products, reduced or meat-free diets, and diets based on current health standards.

–The choices we make about the food we eat affect our health and have major ramifications for the state of the environment. The food system is responsible for more than a quarter of all greenhouse gas (GHG) emissions of which up to 80% are associated with livestock production. The aggregate dietary decisions we make thus have a large influence on climate change. High consumption of red and processed meat and low consumption of fruits and vegetables are important diet-related risk factors contributing to substantial early mortality in most regions while over a billion people are overweight or obese . Without targeted dietary changes, the situation is expected to worsen as a growing and more wealthy global population adopts diets resulting in more GHG emissions and that increase the health burden from chronic diseases associated with high body weight and unhealthy diets.

-We find that the impacts of dietary changes toward less meat and more plant-based diets vary greatly among regions. The largest absolute environmental and health benefits result from diet shifts in developing countries whereas Western high-income and middle-income countries gain most in per capita terms. Transitioning toward more plant-based diets that are in line with standard dietary guidelines could reduce global mortality by 6–10% and food-related greenhouse gas emissions by 29–70% compared with a reference scenario in 2050.

-A global dietary shift would save an estimated 79 million lives and avoid 5.1 million deaths per year. Estimates for a completely vegan diet project closer to 129 million lives saved and 8.1 million deaths avoided. These projections also saw trillions of dollars saved in health care costs by 2050.

-We find that the monetized value of the improvements in health would be comparable with, or exceed, the value of the environmental benefits. Overall, we estimate the economic benefits of improving diets to be 1–31 trillion US dollars, which is equivalent to 0.4–13% of global gross domestic product (GDP) in 2050. However, significant changes in the global food system would be necessary for regional diets to match the dietary patterns studied here.

-Changing diets may be more effective than technological mitigation options for avoiding climate change and may be essential to avoid negative environmental impacts such as major agricultural expansion and global warming of more than 2 °C while ensuring access to safe and affordable food for an increasing global population.”

-Here’s to eating more grains, vegetables and fruit to replace meat and dairy for the sake of our health as well as the health of our children (and theirs as well)!




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