Interesting article in Business Week: Relax and Enjoy the “Greenspan Lag”
EXCERPT: The Fed chief has a history of waiting until the last minute before hiking rates, and it’s still a long way from that point
With the cyclical turn in the labor market behind it, the next big milestone for bonds will be the shift in course for Federal Reserve policy. At MMS, we expect Chairman Alan Greenspan to reveal his historic tendency to take longer to initiate a round of interest-rate hikes than most monetary-policy hawks would like — but to then raise rates more, and faster, than expected.
Greenspan waited until 1994 to start the tightening cycle after the 1990-91 recession. But he was able to launch it with a “surprise tightening,” and then proceeded to raise rates so severely that the economy was nearly pushed into a premature recession. Similarly, the chairman has been blamed for fueling the global financial market bubbles with only one small tightening through the 1996-97 boom, bracketed by glowing assessments of the “New Economy,” despite widespread calls for more significant rate hikes.
The ensuing four years were spent in mop-up operations around global financial market “bubble burstings” that might have been smaller had they been contained in advance . . .
Source:
Relax and Enjoy the “Greenspan Lag”
Michael Englund (chief economist for MMS International)
ECONOMIC INSIGHT, NOVEMBER 13, 2003
http://www.businessweek.com/investor/content/nov2003/pi20031112_5739_pi031.htm
If you know its coming, it’s not a surprise.
A real surprise would be the PPI settles down .1, .2 for the 4th qtr 04 and 1st qtr 04.
The economy 1st qtr 2004 is flat if not slightly down ward. And then in March the Fed CUTS, Yes I said cuts the discount rate. Now that would be a surprise!
A note on the Fed model. A table I made from 1987 to 2003 showed the median earnings yield was 75% of the 10 yr bond yield, which indicated that was “normal.” Going back to 1900-1950 however, bond yields were greater than stock yields. That indicates yield and risk (volatility) are joined at the hip.
In the first half of the twentieth century people perceived stocks as riskier than bonds and they were priced accordingly. In the second half though, investors believed bonds were risker than stocks. Probably due to the threat of inflation.
That seems to be the current thinking: stocks are the best bets in the long run and therefore deserve the smallest risk premium, i.e. largest p/e. The VIX almost serves as a proxy for earnings yield.
Until the mind set changes stocks will retain their premium.