Unexpectedly Intriguing!
07 January 2014

It's time to play some catch up with all that has happened since 16 December 2013, when we last checked in on the S&P 500!

At that time, we had observed that a new noise event had begun to negatively affect stock prices beginning on 10 December 2013, this time driven by the uncertainty related to just how large the tapering of the Fed's quantitative easing programs would be. That noise event ended on 18 December 2013 when the Federal Reserve announced that it would only cut back its monthly purchases of U.S. Treasuries and Mortgage-Backed Securities by $5 billion each, which would lower its combined average monthly purchases of these securities to $75 billion per month beginning in January 2014.

During the interval of that noise event however, investors appear to have shifted their forward-looking focus in setting today's stock prices toward the change in growth rate expectations for dividends that will be paid in the future quarter of 2014-Q4, where it now stands. Prior to that shift, investors had been focused on 2014-Q1 in setting stock prices, which had been the case for much of 2013.

The QE Taper Size Noise Event of 10-18 December 2013 and the shift in investor forward-looking focus may be observed in the latest update of our favorite chart. We've also slid the time scale to the left to make room for the data of the first six months of 2014 in this version, which we'll update periodically in 2014 (a full 2013-only version of this chart appears later in this post.)

Change in Growth Rates of Expected Future Trailing Year Dividends per Share with Daily and 20-Day Moving Average of S&P 500 Stock Prices, through 3 January 2014

This update of our chart also shows what the change in the growth rate of stock prices were after accounting for the echo effect we anticipated from 2012's Great Dividend Raid Rally (the dashed orange line). Here, without accounting for the echo effect, we would have observed much of the period from 15 November through 21 December 2013 as being a rather large negative noise event (as evidenced by the dotted blue line), even though there was, in reality, very little noise outside of the Fed QE Taper Size Noise Event that ran from 10 December through 18 December 2013.

The echo effect is an artifact of the math we've developed to translate the amount of expected future dividends into today's stock prices, where we typically use the recorded stock prices of a year earlier as our base reference point in determining the growth rate of today's stock prices. We had previously predicted that it would be evident in the data for the period between 15 November and 21 December 2013, which corresponds to the stock price rally that accompanied the Great Dividend Raid of 2012, with the effects we observed.

In practice, our echo filtering technique worked well up until the QE Taper Size Noise Event began, and we can even see that remained the case even after investors shifted their forward-looking focus in setting stock prices to the more distant future quarter of 2014-Q4.

The shift in focus to the change in the year-over-year growth rate of 2014-Q4's expected dividends per share will coincide with much more slowly growing stock prices than was the case in 2013. Absent noise events and significant changes in the amount of dividends expected to be paid in that future quarter.

Speaking of which, our second chart shows what 2013 would have looked like without the year's four major noise events:

Dividend Futures Model-Based Forecast S&P 500 Value vs Actual, 1 January 2013 through 31 December 2013

Stock prices behaved largely as expected throughout 2013, keeping within the range we would expect them to be given typical low levels of noise in the stock market, and moving to converge with our dividend futures-based target levels following shifts in the forward-looking focus of investors, significant changes in the amount of dividends expected to be paid in the future quarters to which they focused their attention, and also in the aftermath of noise events.

Our final chart shows how these events appeared on our favorite chart:

Change in Growth Rates of Expected Future Trailing Year Dividends per Share with Daily and 20-Day Moving Average of S&P 500 Stock Prices, 1 January 2013 through 31 December 2013

One of the things that's kind of interesting about what we do is that our signal and noise model of how stock prices behave largely reconciles the differences between the theories of Eugene Fama and Robert Shiller, both of whom shared the Nobel prize in economics in 2013. Both are right, as far as they go, but neither really gets the full picture.

But that's a topic for another post at a more distant point in the future. Set your forward-looking expectations accordingly!...

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