Saturday, July 26, 2014

Is the Fed Contributing to a Stock Market Bubble?

Former student PA brought this article from The Motley Fool to my attention: “Is the Federal Reserve Fueling the Greatest Stock Market Bubble In History?

The conclusion of the article is that no it isn’t, mainly because the author doesn’t consider us to be in a bubble. I’d agree with that.

But, here’s some thoughts about the rest of the article:

  1. The chart stinks: the data a) isn’t logged or b) the vertical axis isn't log scale, or c) reported as growth rates. A stock index can reasonably be expected to grow through compounding. I would be immediately suspicious of anyone presenting a position that doesn't do that (although I will cut people some slack because many people aren't aware they should do that).
  2. Other issues with the chart: a) the S&P has been around for a long time — what position is being pushed by focusing on only its recent behavior, b) the vertical scale does not have a zero even though the S&P is ratio data, c) red explosion graphics — spare me, d) compared to what — why is this bad, is it worse than some other investment?
  3. Do bubbles happen? Yes. Should we worry about them? Yes. Can anyone predict them? Not really ... if you check their records.
  4. Can the Fed cause bubbles through monetary policy? Hmmm. The jury is still out on that, and we've done a lot of research on this over the last 40 years. Does the Fed get blamed anyway? Yes.
  5. The whole part about low interest rates leading to rational price inflation rather than an irrational bubbles is spot on.

In sum, I think the presentation of the article is overwrought, but the conclusion is OK.

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