The Fed caused 93% of the entire stock market's move since 2008
finance.yahoo.com
finance.yahoo.com
I also don't think the market is neatly divided into segments of having a single dominant driver. That's a major assumption about how the market works, and is supported by simply finding 'flat spots' on the many charts produced.
I think this is valuable analysis, but conclusions like "the Fed caused ..." are just nonsense. A smart investor could use this information to look for trend changes, but they do not explain the market.
http://www.federalreserve.gov/boarddocs/Speeches/2002/200211...
The reason is that given any dataset, you can come up with thousands of stories that explain the data perfectly, but have no predictive power. This is also called 'overfitting' in machine learning contexts.
However, a prediction made before events can use those events as evidence of the correctness of the theory.
What is the evidence for the theory in this article? Well, it is that it explains past events. But those events can't be used as evidence for the theory, and if that is all there is, this is a 'just so story'.
Another way to say this is: "The fact that a theory does not conflict with existing observations is not evidence that it is correct."
Edit: If you mean that you need to state the theory before you make the observation for the observed data to be valid evidence for or against the theory, you are correct, this is very nearly contrapositive of the scientific method.
Two things immediately come up when looking at economic theories:
1) a LOT of them (the ones "followed") are "by" high-level Fed officials. Biggest example: Keynesianism.
2) They all seem to have the same conclusions (government needs to spend more, either directly or through the fed or finance dept)
3) because these people want to but can't be bothered to manage an economy (meaning hundreds of thousands of small companies) they massively advantage large corps over everyone else.
That's complete nonsense. Theories are almost always made after collecting observations.
They may be confirmed using future observations, or by statistical analysis, however.
There is nothing wrong with looking back to see if a variable explains an observation. However, the true test of the hypothesis is predicting future events.
Because we can't trust people, future is a safe and sufficient choice. It's not necessary. (That's why machine learning people use hold-out sets.)
There was nothing rigorous about his analysis, while I'm inclined to agree with his hypothesis I just don't see a logical line of reasoning.
Engle and Granger came up with a stronger measure of time series association called "cointegration" that would be more appropriate to use here than regression. Including such an analysis would strengthen the article.
For static measures - balance sheet type things - it was huge. For dynamic measures - increased M3 or GDP or what have you - it was a non-event.
The Truth is the Fed Continues to purchase Treasury Bills and Mortgage Backed Securities for all that reach maturity. More than half of the purchases during QE mature within 5 years, as it stands now rather than allowing the Bonds to Mature and Come off the balance sheet the Fed simply repurchases them, what they aren't doing is increasing the amount of purchases as they were during QE.
This is why the amount of Treasuries and MBS owned by the Fed has remained constant more than a year after QE ended.
$2.4 Trillion in Treasuries https://research.stlouisfed.org/fred2/series/TREAST and $1.75 Trillion in Mortgage Backed Securities https://research.stlouisfed.org/fred2/series/MBST
One starts with a big risks banks would go bankrupt as a result of an asset bubble.
One gets the government to fix things using an unlimited supply of government spending. Stir thoroughly, and we get :
Big risk that big banks AND the government will go bankrupt (ie. hyperinflation, because "governments can't go bankrupt") as the result of an asset bubble.
The economy is highly complex, and I suspect that using 5 variables to describe it is wrong.
Additionally, the writer doesn't mention this, but if the Fed bought up equities as part of their quantitative easing program and the market grew and recovered further, then their assets would naturally grow with the market. I don't think this was accounted for.
The stock market is not the economy...
The most famous one I can think of is the pre-FOMC announcement drift (https://www.newyorkfed.org/medialibrary/media/research/staff...). The authors observe that "80% of annual realized excess stock returns since 1994" are accounted for by the 24 hours of trading before an FOMC announcement. If we take this as evidence that the Fed "causes" most of the stock market's move (which we probably shouldn't), the effect is nothing new.
I agree interest rates need to go up, but rising rates aren't going to improve the housing market. When I graduated from college the housing market in my area was booming while rates were at 12%. If you think you can't afford a house now, wait until your 3k monthly payment buys you a $150k house.
Also, house prices do not necessarily go down when interest rates go up. If interest rates are rising because of inflation people rush into the housing market looking for an asset that will hold its value. You may end up with the worst of both worlds - $1.5m houses (in constant dollars) and 12% interest rates. Just because all you can afford is a $150k house doesn't mean one will be available at that price.
It just doesn't make sense for the banks to do mortgages at the moment. They're losing money on it. A little bit at the moment, but if the default rate were to go up by even 1%, God help us. Banks would be dropping like flies.
That's of course what bubbles do : they make the system more unstable. But that's what everybody's denying as well, despite the fact that a trivial excel sheet will tell you the obvious. A tiny problem will crash the system at the moment. Especially in Europe.
If the government owns those loans, once their losses accelerate ... well ... we know how they "fixed" that problem for student loans.
http://www.forbes.com/sites/stephendash/2015/10/25/why-stude...
http://www.bankrate.com/finance/student-loans/student-loan-h...
Housing prices will always inflate to the level where people can barely pay them, but will pay because they have to.
That's the case for a limited supply of housing. If not for political problems (read NIMBYs), we could build a lot of housing. The sky's the limit.
In any case, higher interest rates would make these levels go down.
I know you cringe thinking about those asset types. That's partially why they're undervalued in the first place - Did you buy Vancouver property in 1998-2001 when it was cheap, or in tech stocks at the time?
In fact, I think his graph suggests the opposite of his conclusion: which is that fed assets should maintain a steady ratio with equity values for strong economic growth. The times when they diverge coincide with economic bubbles.