It has been eight years since the great financial crisis of 2008, and the Federal Reserve (Fed) is still maintaining an unprecedented level of accommodation in monetary policy. The Federal Funds rate has been pinned at or near zero since 2008. Recent discussions on raising the rate a mere quarter of a percent are met with a palpable level of angst and incredulity by economists and investors alike. Since the crisis, the Fed quadrupled their balance sheet using printed money to buy U. S. Treasury and mortgage securities. The economic results, supposedly the justification for these aggressive actions, have mostly been disappointing. That said, one can credit Fed policy actions for driving financial asset valuations to historic levels.
Over the last eight years investors have adopted a mindset that Fed intervention is good for asset prices, despite clear evidence that it has contributed little to the fundamental rationale for owning such assets. Fixed income yields are at or near record lows and stock indices trade at valuations that have only been eclipsed twice in history, just prior to the great depression (1929) and at the height of the technology bubble (2000). High end real-estate and various collectibles trade at unparalleled levels. The eye-popping valuations on these less liquid assets further confirm how impactful Fed policy has been on asset prices.
We have written numerous articles highlighting rich valuations and the infectious behavior that can compel investors to make investment decisions that they would not otherwise make. In this article we employ a cash flow model to quantify the potential ramifications on the equity market. The goal is to provide investors with a simple tool to calculate total return outcomes that could occur if investors were to lose confidence in the Fed and as a result stretched market valuation premiums built up since 2008 diminish or vanish altogether.
This post was published at Zero Hedge on Sep 26, 2016.
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