tag:blogger.com,1999:blog-8152901575140311047.post6111730300983800974..comments2024-03-29T07:41:47.433-04:00Comments on Musings on Markets: The Fed, Interest Rates and Stock Prices: Fighting the Fear FactorAswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comBlogger33125tag:blogger.com,1999:blog-8152901575140311047.post-37019966838955314562016-09-10T16:14:01.408-04:002016-09-10T16:14:01.408-04:00New academic research suggests that PE ratios shou...New academic research suggests that PE ratios should be viewed in relation to the after-tax yield on corporate bonds, as I explain in the article below. <br /><br />http://seekingalpha.com/article/4005194-stock-market-overvalued-ask-corporate-bond-market<br /><br />Ianhttps://www.blogger.com/profile/12517066769655627220noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-71770425470410778302016-08-26T14:43:03.009-04:002016-08-26T14:43:03.009-04:00Maybe No reinvestiment due to low expected growth?...Maybe No reinvestiment due to low expected growth?<br /><br />Anonymoushttps://www.blogger.com/profile/11290854975075336292noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-52355432699817424192016-06-16T02:00:55.039-04:002016-06-16T02:00:55.039-04:00I thought to revisit this blog to un-cloud my thi...I thought to revisit this blog to un-cloud my thinking on the role of fed. It seems we are back to the guessing game of whether fed will increase rates or decrease or keep it the same. I just find the fascination with the rate mind boggling and hard to reconcile with your post.<br /><br />While reading, I was also wondering if there is any link between historical low rates hence companies being able to borrow cheaply and " the primary driver of stock prices" as mentioned in your post? <br />I.e. if companies can borrow cheaply would it make sense to increase leverage and return shareholder capital (given it is more expensive) <br /><br />Raj Rainahttps://www.blogger.com/profile/09490677056881589111noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-80964657190846187872015-10-09T11:53:05.030-04:002015-10-09T11:53:05.030-04:00Prof. - What about the thought that maybe cash flo...Prof. - What about the thought that maybe cash flows (dividends + stock buybacks, as you define them) are so high because stock buybacks are at all time highs - which in turn have been fueled by ultra-low interest rates themselves. Take Apple, for example, who's issued $20+ billion in debt this year just for stock buybacks (even though they have $200 billion in cash). See this article here: http://www.reuters.com/article/2015/09/23/us-usa-fed-buybacks-analysis-idUSKCN0RN0D320150923.Johnhttp://vintagevalueinvesting.comnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-83441661851538309532015-09-27T14:53:19.803-04:002015-09-27T14:53:19.803-04:00Dear Professor,
How would you explain the drastic...Dear Professor,<br /><br />How would you explain the drastic drop in interest rates in PIGS following the "whatever it takes" comment? To me, it shows the power ECB and FED have in dictating interest rates. Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-30383927742955379032015-09-16T16:26:10.875-04:002015-09-16T16:26:10.875-04:00Dear Professor,
As regards your point 2- Low inte...Dear Professor,<br /><br />As regards your point 2- Low interest rates are the Fed’s doing- I just find these interesting Speech (http://www.federalreserve.gov/newsevents/speech/fischer20150227a.htm) by Stanley Fischer who says "Fed's balance sheet programs are currently depressing 10-year Treasury yields by about 110 basis points. What do you think about it? I mean, it's pretty obvious that you are on the opposite side but how can you sustain that FED actions has actually little or no consequences on Interest rates ? It sounds really strange to me.<br /><br />LuisAnonymoushttps://www.blogger.com/profile/08792140276279836436noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-20827555821622913602015-09-15T16:07:34.315-04:002015-09-15T16:07:34.315-04:00Hello Professor,
I think there are a few fallacie...Hello Professor,<br /><br />I think there are a few fallacies and inaccuracies with respect to your explanation of the realities of the first myth. There are many types of interest rates for different purposes and maturities.<br /><br />For one think the federal reserve doesn't directly set the Fed funds rate. It controls the rate by using temporary open market operations (TOMOs) called repurchase agreements (repos) but it doesn't directly set the overnight interbank lending rate. A Repo is where the federal reserve buys short term treasuries (3 month maturity) from the primary dealers (e.g The main American banks) which adds liquidity to the reserves of the banks and this reduces the need for them to borrow against each other. However like the interbank lending the repo is a very short term loan (1 day) so the banks need to pay back the fed with interest. The interest is usually really small (0.05%) though as it is such a short term.<br /><br />The Fed Funds rate is effectively 0 to 0.25%. I don't think the primary deal banks even lend to each other now because they all have way too much reserves at this current time.<br /><br />Unlike the federal funds rate which the fed does not directly set the federal reserve does set the discount window rate which is a liquidity buffer incase of bank runs and the likes. That rate is set at 0.75%.<br /><br />The Federal Reserve also sets another interest rate which has been around since 2008 as far as I am aware called the interest on excess reserves. Because of QE (1,2,3) banks are awash with reserves and have excesses of about $2.6 trillion as far as I am aware. The federal reserve is actually paying interest on the excess reserves of the main banks. This rate is about 0.25% so it accounts to about 6 billion dollars a year of risk free money for the banking sector. ;).<br /><br />I am not an economist myself but I do like the Austrian school as it seems very logical to me. For one thing when you saw "To me, the answer seems self evident. Interest rates in the US (and Europe) have been low because inflation has been non-existent" what does inflation even mean to you. I would love to get a clear definition of what inflation is and logically what is the causation between your definition of inflation and interest rates.<br /><br />It is interesting to speculate on what will happen in the future with respect to what the Federal Reserve will do and how it will affect the economy. So we are in a strange situation where banks are sitting on $2.6 trillion of excess reserves. I am assuming that the Federal Reserve does not want that money to flow into the economy because I am pretty sure that would cause increased consumer prices and that is why it is currently paying $6billion dollars to the banking system every year. So if the federal reserve increases its targeted federal funds rate to 50 basis points then I wonder what will happen? <br /><br />Currently the IOER 0.25% is higher than the fed funds rate (0.00) so they don't really have any incentive to lend to each other but what will happen if the fed funds rate goes up to 0.50%. Will it even matter because there is currently too much money in reserves? I don't know to be honest. I suppose if banks can find a way to make a risk adjusted return that is higher than the IOER return on its excess return they will find away.<br /><br /><br />Brendan.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-14018817187135155902015-09-14T13:26:03.219-04:002015-09-14T13:26:03.219-04:00Dear Professor
How do you think the Fed action or...Dear Professor<br /><br />How do you think the Fed action or inaction will affect emerging markets. Will Fed action on increasing rates entice FII's to move away from an emerging market say india.?<br /><br />Avisek sarkarAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-17643264405793160472015-09-10T08:34:54.479-04:002015-09-10T08:34:54.479-04:00I wouldn't argue with the Taylor Rule, but tha...I wouldn't argue with the Taylor Rule, but that's a really, really long run relationship that doesn't appear overnight. You can't seriously call the QE actions "modest" when the % of Federal Debt held by the Fed has increased from 6% to 16%. All of those risk free assets suddenly no longer in the market has an impact. <br /><br />http://oi62.tinypic.com/6xw3dw.jpg<br /><br />Maybe, at the least, the Fed made the descent in interest rates faster than the long run expectations of growth and inflation would have, but that's hardly the picture of impotence you seem to be painting.<br />Unknownhttps://www.blogger.com/profile/06662201005690412179noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-33017937512991770712015-09-09T13:13:06.837-04:002015-09-09T13:13:06.837-04:00Professor,
I would argue that cost costing is not...Professor,<br /><br />I would argue that cost costing is not nearly finished yet. From my experience most manufacturing companies still have enormous opportunities to cut costs and increase production (after initial capex) by adopting robotic platforms (fanuc, abb, kuka, etc.). These robots are also continuously getting much cheaper. On the IT front most companies, even those in high-tech, still have huge run-ways in reducing cost and improving efficiency (discounting time spent by employees on social media) by leveraging cloud solutions and software systems. For example most companies have moved onto the Salesforce CRM platform but from my personal experience I would say most of the large tech companies I have worked with are leveraging those "common" technologies very poorly. They are using those systems are a fraction of their potential; this should change as more tech-savy workers start to dominate the work force and with a lot of help from outsourcing. <br /><br />derMenschderMenschnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-47224143441139640302015-09-08T15:36:13.005-04:002015-09-08T15:36:13.005-04:00Uday,
The point about seriousness had nothing to d...Uday,<br />The point about seriousness had nothing to do with the questions but about the forum for those questions. A comment section in a blog is not a good place for an extended Q&A. It is where you pick the one or two points that you disagree with (or agree with) and make your point, not seventeen. That has to wait for another time and another day!Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-13370093142144409282015-09-08T08:41:47.378-04:002015-09-08T08:41:47.378-04:00Professor
Is that the reply for those queries ? ...Professor <br /><br />Is that the reply for those queries ? Am serious.<br /><br />So you believe market determined Zero or lowest rate for last 6 years post 2008 crisis.Fed has no or negligible influence on it. <br /><br />Fed asset purchase has no impact on financial asset price inflation especially bonds & stocks. <br /><br />Record cash flow during the period of great recession (post 2007) for the corporate comes from emerging economy earnings growth and workforce layoffs.What was the position of dollar against emerging currencies during the record cash flow ? <br /><br />Stock market is up due to business cycle fundamental, earnings growth and record cash flow. <br /><br />Can you share the chart on Fed asset purchase vs Bond yields, Corporate yields, Stock prices, GDP for these years (2009-2014) Also share dollar index chart during this period. <br /><br />Credit cycle started uptick now ? money velocity started uptick now US economy started showing growth uptick now ?<br /><br />Am completely in agreement with regards to your conclusion part about market, it cannot be overrun by central bankers in long run through all those short term smoke and screen attempt, gimmicks. central bankers are over hyped entities and misplaced confidence on their ability to save the day. Market will revert to its sense one way or other.<br /><br />But disagree with you on Fed asset purchase, zero rate influence on financial market and its asset prices, I mean in short or medium term central bankers rule market participants with awash of unlimited liquidity as false hope of stability and confidence .<br /><br />Thanks and Regards<br />Udayakumar D Anonymoushttps://www.blogger.com/profile/17002032883101230586noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-5536360603125716182015-09-08T07:44:52.621-04:002015-09-08T07:44:52.621-04:00Uday,
You cannot be serious!Uday,<br />You cannot be serious!Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-91024021288841934232015-09-08T07:44:00.183-04:002015-09-08T07:44:00.183-04:00Erikwim,
If the point of my post was to argue that...Erikwim,<br />If the point of my post was to argue that stocks were under valued today, your point about the cash flows would be a reasonable one. In fact, you are making exactly the point that I was too, which is that the bigger danger to stocks is not a rise in rates, per se, but a drop in cash flows. As for what to scale the bond buying to, you are welcome to try another denominator, but the basic question remains: does the Fed bond buying significantly affect interest rates and my gut tells me that the effect is far more marginal than the Fed (and those who obsess about QE make it out to be). On the question of whether bond markets are slow to adjust to changes in fundamentals, I tend to agree with you that there is a lag between shifts in fundamentals and changes in bond rates. So, as an investor, you should factor that into your decision making. Again, that is not the focus of this post but perhaps deserves one of its own.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-46346525827770544012015-09-07T12:04:33.716-04:002015-09-07T12:04:33.716-04:00Great food for thought, so after some digesting, h...Great food for thought, so after some digesting, here are my musings:<br /><br />I find the reasoning on stock valuations odd. Following your logic of cash-flow returns and looking at your figure 2, stocks were overvalued in 2003 and 2009, and undervalued in 2007 and 2008. It is anyway advice for disastrous investment performance. It follows the prudent investor should see the high pay-out % and high 'cash-flow' -return as a warning sign and liquidate partly.<br /><br />Comparing fed bond-buying to the daily trade in the bond market is also questionable. The fed is buying to hold, and will turn around next day or hour or second or millisecond or picosecond, to put the bond on the market again. In contrast that is exactly what is happening in bond markets. So the correct comparison should be QE volume relative to total US govt debt outstanding and/or QE volume compared to new govt bonds issues in the same time period. <br /><br />Finally your claim that interest rates follow fundamentals seems to be at odds with your figure 1. What that figure brilliantly shows (and i realized a long time ago) is bond rates more or less act as if current rates will prevail in the future. Long-term bond rates did not 'see' the run up in inflation coming in the 1960-1980 period, nor did they 'see' the steady decline in inflation coming from 1980-today. Far less then reflecting true fundamentals they seem to reflect yesterday, today and tomorrow. <br /><br />Ok, not finally, another one: it is correct that lower future real and inflation growth affects company's cash-flows, but not so much valuations. Lower inflation in free cashflows is mostly compensated by the same lower inflation in the discount rate, and the same holds for long term real growth expectations. And anyway these cash-flows have to be discounted way past the 10 year horizon, at which point the best assumption is probably to take a historic average for both. Erikwim Duringnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-33969253375322692722015-09-07T08:35:20.468-04:002015-09-07T08:35:20.468-04:00Actually if you graph the effective fed-funds rate...Actually if you graph the effective fed-funds rate on FRED you can see the effective rate, the average obtained from loans reported by Fed-Funds brokers, varying day-to-day.<br />https://research.stlouisfed.org/fred2/graph/?g=1MboJonhttps://www.blogger.com/profile/02452892938623254025noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-27433236094840199632015-09-07T08:26:26.959-04:002015-09-07T08:26:26.959-04:00Rick,
Finding yourself in agreement with Paul Krug...Rick,<br />Finding yourself in agreement with Paul Krugman on anything to do with financial markets is usually a bad sign, since he is almost invariably wrong on that front. (I know that he has a Nobel prize, but even Nobel prizewinners can have blind spots.) Second, you are right that the Fed's power can come from its signals, but for those signals to actually matter, it has to be credible, and to be credible, it has to behave like an independent central bank. In other words, if the economy is actually strengthening but the Fed acts as if it is not, it is weakening its credibility to send future signals to markets. Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-21784680114669591792015-09-07T08:22:13.929-04:002015-09-07T08:22:13.929-04:00Jon (and Anonymous),
You are right, technically, o...Jon (and Anonymous),<br />You are right, technically, on the Fed actually setting the rate at which banks borrow from its window, rather than the Fed Funds rate, but the Fed Funds rate is too static to be a market-set rate. So, the Fed implicitly must set that rate too.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-10578887648788706872015-09-07T07:00:55.964-04:002015-09-07T07:00:55.964-04:00Technically, the fed does not even set the Fed Fun...Technically, the fed does not even set the Fed Funds rate, it buys and sells securities---typically short term treasuries---to get the Fed Funds overnight rate towards its target. The true "Fed Funds" effective rate is determined by the market for interbank lending.<br /><br />The Fed does set the rate it pays on excess reserves "Interest on Overnight Excess Reserves" (IOER) which is now 25 bp. It also sets the rate at which it lends through its discount windos.Jonhttps://www.blogger.com/profile/02452892938623254025noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-18491344321685428142015-09-07T00:06:34.112-04:002015-09-07T00:06:34.112-04:00Professor,
Thanks for your article,
1 Everyone a...Professor,<br /><br />Thanks for your article,<br /><br />1 Everyone aware centra bank sets only fund rate directly but have very minimal impact on long end curve. Point is when market see largest single buyer on daily basis enter market with objective of bringing long end curve , what would expect other participant to do take position against them or front run them, follow them ? Will this be captured as part of the equation you mentioned by rate Tylor equation ? Question is how long they can hide the real effect of economy on rate..<br /><br />2 What they did with operation twist 1 & 2 ? <br /><br />3 how much bank deposit earn in US banks ? Who decided ? <br /><br />4 when USA, Europe, japan were down with high structural deflation where would emerging economy got their growth out when they are primarily export oriented economy ? What is the percentage of corporate earnings come from emerging country in relation to developed economy ? Can corporate get record cash flow with labor restructuring and 3rd world economic growth ?<br /><br />5 what is the size of dollar carry trade due to FED liquidity pump into financial world ? Have we learned anything from japan experiment of least rate financing fueled carry trade and its impact of it in other market and their currencies ?<br /><br />6 who had access to free money from FED ? What did they do with that money ?<br /><br />7 how much is capex spending by record high cash flow corporate ? What is the rate of change of debt to equity ratio during this period of record low rate ? How much of eps expansion is supported by corporate buyback program and real earning growth ? <br /><br />8 what is the deficit USA was running during this period ? What is the relative size of FED asset purchase to it ?<br /><br />9 who is the largest holder of USA debt today pls consider FED too in this ?<br /><br />10 Alan Greenspan or Paul Volcker or Ben didn't lower or raise rate ? Can we see the Treasury rate chart during their times ? <br /><br />11 you mean market determined all time low rate without influence of FED sensing purely based on forth coming deflation ? When was we had this lowest rate in USA history ? When was bank deposit earned this lowest rate ? Great depression ?<br /><br />12 recent yield inching high is the recognition of market about FED limited power in suppressing it in absence of big ticket asset purchase ? Emerging economy selling Treasury to meet their end ? Unwinding of dollar carry trade ? Or US growth ?<br /><br />13 what would be the impact of US growth on other economies and vice versa in your understanding in current scenario ?<br /><br />14 was 2008 credit crisis a liquidity issue or insolvency ?<br /><br />15 what would be increase of interest amount & it's impact on tax, deficit due to rate normalization ? What would be impact of the same on corporate bottom line with renewed deflation across globe ?<br /><br />16 what is the size of USA debt today ? Rate of change of it post 2009 ?<br /><br />17 what is the impact of BOJ, BOE, ECB, PBOC stimulus balance sheet expansion on financial market ?<br /><br />And many more factor , questions have which may not fit in mathematical equation to define situation for interpretation.<br /><br />Thanks and Regards<br />Udayakumar D<br /><br /><br /><br /><br /><br /><br /><br /><br /><br /><br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-31545336069155725722015-09-06T17:11:29.238-04:002015-09-06T17:11:29.238-04:00Is it strictly true that the Fed only sets one int...Is it strictly true that the Fed only sets one interest rate, the Fed Funds rate? I thought I had recently learned that they also set another rate, perhaps more than one, the "discount window" rate, which is also a very-short-term rate.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-4363456640099925672015-09-06T10:43:02.690-04:002015-09-06T10:43:02.690-04:00Janet Yellen and the rest of the members of the Fe...Janet Yellen and the rest of the members of the Fed don't need levers to raise interest rates, they have a megaphone. Recent speeches have indicated that several members of the FED feel that interest rates should rise to constrain the possible threat of inflation. Paul Krugman emphatically disagrees and so do I:<br />http://krugman.blogs.nytimes.com/2015/09/04/the-fed-should-remember-the-90s/?module=BlogPost-Title&version=Blog%20Main&contentCollection=Opinion&action=Click&pgtype=Blogs&region=Body<br /><br />What the Fed <i>says</i> about interest rates is as or more important than what it <i>does</i> about rates because, as you point out, in ordinary circumstances there is little they can do beyond the Federal Funds rate. But part of the Fed's strategy for the past few years has been to broadcast it's intentions and the data on which they are based. This had the effect of holding down rates because the Fed has emphasized the low levels of inflation and unemployment in the sluggish economy. While the 2d estimate of GDP shows a healthy 3.7% rise, that is coming on the heels of a -0.2% 1st quarter. The Chicago FED's National Activity Index "suggests that growth in national economic activity was at its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests limited inflationary pressure from economic activity over the coming year." That doesn't sound to me like a wave of inflation is imminent. http://app.frbcommunications.org/e/er?s=1064&lid=3537&elq=1042cc9d1aab40ff8eecfd1003e277d5&elqaid=9258&elqat=1&elqTrackId=d7eb51c8108d4cc9b0de993d4368f5c3<br /><br />Personally I see nothing to indicate the onset of inflation above the 2% level, but what do I know? And while a 0.25% uptick in the Federal Funds rate will have little to no impact on the economy, it is the threat of continued increases that can depress markets and the wealth effect.<br /><br />You may get your wish for a rate increase Dr. Damodaran but markets never fight the FED so they'll sell off.Rick Raphaelnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-12189199488026891202015-09-05T13:51:08.931-04:002015-09-05T13:51:08.931-04:00Professor, I have a question about the following l...Professor, I have a question about the following line from your post: "In my most recent update on this number at close of trading on August 31, 2015, I estimated an expected return of 8.50%, almost unchanged from the level in 2009 and higher than the expected return in 2007."<br /><br />It is counter-intuitive to believe that expected returns in 2009 were the same as they were in Aug 2015. Earnings in 2009 were at a trough and would be expected to revert to a higher level, whereas now earnings are at all time highs and may revert to a lower number. Why not use some sort of earnings smoothing / normalized earning measure which would likely result in much higher expected return in 2009 vs. 2007 or 2015?PMhttps://www.blogger.com/profile/07815853830372902348noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-20176579826261947442015-09-05T12:53:42.432-04:002015-09-05T12:53:42.432-04:00This is a great post as always. But wouldn't t...This is a great post as always. But wouldn't the lending rate fo down and thereby cost of debt which would ultimately lead to reduction in WACC having impact on the value of the business and thereby value of equity? If Banks can raise cheap money (With lower Feds funds Rate) and lend at a lower rate - shouldn't this impact be felt? <br /><br />Requesting if you could share some light on this. <br /><br />Thank you.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-21179990254898044872015-09-05T10:54:55.836-04:002015-09-05T10:54:55.836-04:00Your data about the relative importance of the Fed...Your data about the relative importance of the Fed's purchases of Treasuries and therefore its impact seems at odd with for example:<br /><br />http://www.nytimes.com/2014/02/22/business/economy/no-surprise-fed-was-biggest-buyer-of-treasuries-in-2013.html<br /><br />Would you care to explain ?<br /><br />Also I fear that your conclusion is wishful thinking. Too many people make a living out of "Fed Watching" for that "noise" to disappear once we see the first rate increase.Michelhttps://www.blogger.com/profile/12840661488774594731noreply@blogger.com