Unexpectedly Intriguing!
18 February 2014

We were wrong. Although it would make our math simpler to do, the data said that we're not going to be able to dispense with accounting for the echo effect in stock prices anytime soon.

We know that's the case because the market gave us an opportunity to calibrate the results of our math last week. Those results indicate that continuing to account for the echo effect will continue to provide a clearer picture of why stock prices are behaving as they are.

For our methods, large and sudden changes in stock prices provide the opportunity to calibrate our math. Since these kinds of changes in stock prices are not randomly-driven, but rather are the result of investors collectively shifting their forward-looking focus from one point of time in the future to another, which occur without significant changes in the expected income that investors might earn from dividends at those different points of time in the future, these events allow us to dial in the scale factor we use in our math.

In this case, it validated the scale factor we've been using since we switched to use the CBOE's dividend futures data in our calculations in October 2013. Let's go to the latest update of 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, through 14 February 2014

The calibration event was the conclusion of Janet Yellen's first congressional testimony as the chair of the Federal Reserve. In her testimony, she made clear that the Fed would continue its policy of tapering off its purchases of U.S. government-issued securities at the measured pace it has established.

Investors, who had previously shifted their attention to 2014-Q2 in advance of the Fed's last Federal Open Market Committee (FOMC) meeting where its Quantitative Easing (QE) policy is set, breathed a sigh of relief and began to shift their forward-looking focus in making investment decisions today to a more distant future: 2014-Q3.

It took a while for us to figure out why that future quarter would be the immediate focus for forward-looking investors in setting today's stock prices following Yellen's testimony. If we project ahead the Fed's FOMC meeting schedule with the established pace at which the Fed is tapering its QE bond buys, the Fed would be likely to announce its plans for how it will finally terminate its net purchases of U.S. Treasuries and Mortgage-Backed Securities at its September 2014 meeting, which coincides with the end of the third quarter of 2014.

In the chart above, the change in the growth rate of stock prices, minus the echo effect, immediately shifted to the future trajectory indicated by the expected change in the year-over-year growth rate of dividends per share for the future quarter of 2014-Q3.

We would not however be surprised if the focus of investors shifted to follow the trajectory defined by the expectations for 2014-Q4. Since investors had been focused on that more distant future quarter before 23 January 2014, and because that's the quarter in which the Fed's QE bond buying would actually end, it would make sense for investors to shift at least a portion of their forward-looking focus to it.

Speaking of trajectories, let's see how stock prices in February 2014 are keeping pace with the different levels that the respective focus on the dividends that would be earned in different future quarters would place them, as the future appeared on 29 January 2014.

Alternative Futures: What Investors Focusing on Different Future Quarters in Setting Expectations Means for the S&P 500

One quick note - the projected decline in stock prices for each of the anticipated trajectories after 19 February 2014 isn't as severe as it appears. Since our method incorporates the stock prices from a year ago as the base reference point from which we have projected where stock prices are likely to fall, what you're seeing here in part reflects the dip in stock prices of a year ago.

If we account for that particular short-lived echo, the decline is still there, but not as great. We're going to test out treating this particular echo like an error, where we would expect that the error bars we've shown around the midpoint trajectory for each alternate future will adequately capture how stock prices are likely to behave during this time. Given the particular echo, we would expect that the actual trajectory will fall in the upper end of the trajectories indicated for a focus on the future quarters of 2014-Q3 and 2014-Q4.

Provided, of course, no new noise events or shifts in investor forward-looking focus in the mean time!

Labels: ,

About Political Calculations

Welcome to the blogosphere's toolchest! Here, unlike other blogs dedicated to analyzing current events, we create easy-to-use, simple tools to do the math related to them so you can get in on the action too! If you would like to learn more about these tools, or if you would like to contribute ideas to develop for this blog, please e-mail us at:

ironman at politicalcalculations.com

Thanks in advance!

Recent Posts

Stock Charts and News

Most Popular Posts
Quick Index

Site Data

This site is primarily powered by:

This page is powered by Blogger. Isn't yours?

CSS Validation

Valid CSS!

RSS Site Feed

AddThis Feed Button


The tools on this site are built using JavaScript. If you would like to learn more, one of the best free resources on the web is available at W3Schools.com.

Other Cool Resources

Blog Roll

Market Links

Useful Election Data
Charities We Support
Shopping Guides
Recommended Reading
Recently Shopped

Seeking Alpha Certified

Legal Disclaimer

Materials on this website are published by Political Calculations to provide visitors with free information and insights regarding the incentives created by the laws and policies described. However, this website is not designed for the purpose of providing legal, medical or financial advice to individuals. Visitors should not rely upon information on this website as a substitute for personal legal, medical or financial advice. While we make every effort to provide accurate website information, laws can change and inaccuracies happen despite our best efforts. If you have an individual problem, you should seek advice from a licensed professional in your state, i.e., by a competent authority with specialized knowledge who can apply it to the particular circumstances of your case.