Using The ‘Fed Model’ To Buy Stocks Has Never Been More Dangerous

Many investors are pointing to low interest rates today as a way to justify soaring equity valuations. Certainly, investors have felt the need to go out on the risk curve to generate greater return when the lowest risk investments offer none. However, the fact that investors have done this, and to anincredible degree already, does not make it a valid investment thesis.
In fact, it’s just the opposite. I feel like a broken record referring time and time again to Cliff Asness’ paper, ‘Fight The Fed Model,’ but it seems there are still a lot of folks, and many professionals even, who haven’t yet read it.
One of the points Cliff makes in debunking the idea that low interest rates should justify high valuations is that earnings growth is very highly correlated to interest rates and inflation. When the latter two are low, earnings growth is low, as well. This is important because in order for low interest rates to actually justify higher valuations then this relationship must not hold.

This post was published at Wall Street Examiner by Jesse Felder ‘ June 6, 2016.