Providing easy money should give a boost to all stock prices, and in fact the Feds actions should give the biggest boost to low risk investments since they are the closest substitutes for what the Fed is buying.
The Fed's policies encourage money to chase risk. When money is 'free' it becomes wildly risk seeking. People that acquire free money do not do the responsible thing and seek safe investments (ask most lottery winners). That's why you see massive asset bubbles develop with low interest rates. The Fed has in fact said it wants to create an artificial wealth effect by leveraging asset bubbles, they wanted to re-inflate the housing bubble for example with toxic mortgage purchases and low mortgage rates.
Don't take my word for it. The US Treasury has stepped forward to admit as much.
http://www.zerohedge.com/news/2013-08-13/us-treasury-finally...
Or take a look at the S&P without the Fed:
http://www.zerohedge.com/news/chart-year-fed-has-doubled-sp-...
Or overlay the S&P with the Fed securities:
http://i.imgur.com/QFHnbBv.jpg
There is now an endless parade of evidence available as to exactly how the Fed creates asset bubbles (we're on our third bubble period right now in just 15 years), and how their programs directly inflate the value of the stock market. The Fed has even taken direct credit for being responsible for as much as 40% of the stock market's value.
On the evidence you are presenting: This doesn't prove that the Fed is causing a stock bubble. The stock market, if anything, is forward looking. Even if the fed was causing a bubble, the kind of patterns you are showing wouldn't be expected. Take the second link, for example. The article clearly states that the stock price gains are made before the FOMC announcements. So somehow the act of making any announcement is causing the market to react in anticipation.
I don't know how to explain these patterns, but they are certainly not good evidence for the Fed causing a bubble.
Monetary policy is very simple and in accordance with the best macro theory we have. The Fed lowers interest rates in recessions, in the hope that it will cause people to consume/invest more and "save" less where saving might include holding hard currency, or safe physical investments. Put in more conventional language, the Fed lowers interest rates to stimulate economic activity.
But this should not be interpreted as trying to cause a bubble. The aim of the Fed is to stimulate economic activity so that both the current efficiency of the economy improves, and beliefs about the future efficiency of the economy are more optimistic. In doing so, it hopes to cause the economy to move from the "unnatural" state in which people are fearful about the future, expect high interest rates, and are unwilling to invest or consume, to the "natural" state in which people are optimistic about the future and expect low (short and medium term) interest rates.
Personally, I don't need more empirical evidence than that.
Fortunately we have a mountain of direct evidence to support my position.
Monetary policy being simple has nothing to do with its results. Cheap money doesn't stay put, it chases returns.
Our supposed best macro policy is a disaster. It has neither contained price inflation, nor produced jobs. Quite the opposite in fact over the last two decades of high level Fed tampering with the economy. Said macro policy is not the best at all, it's standard issue failed Keynesian policy (Japan has been enjoying a similar program for decades as their economy has rotted and accumulated hyper debt).
Not only has the Fed admitted it can create asset bubbles with low rate policies (both Greenspan and Bernanke have acknowledged such); not only has the Fed said that they want to spur asset inflation, to generate a wealth effect (they directly said their goal was to re-inflate housing for example); but the US Treasury and the Fed's own governance board has also stepped forward to say that the Fed's policies directly drive asset bubbles, including in the stock market. The Fed's governance board recently warned that the Fed's policies were creating potentially dangerous imbalances in asset prices; that was a year ago.
Then all the direct correlation data:
"between January 2009 and April 2013, on days in which the Fed POMO was more than $5 billion, the stock market rose a total of 570 points, on days in which the POMO was less than $5 billion, the cumulative stock market gain was "only" 141 points, and when there was no POMO, the S&P gained... -51 points."
OR:
"We show that since 1994, more than 80 percent of the equity premium on U.S. stocks has been earned over the twenty-four hours preceding scheduled Federal Open Market Committee (FOMC) announcements (which occur only eight times a year)—a phenomenon we call the pre-FOMC announcement 'drift.'"
The data points are extraordinarily overwhelming in supporting the fact that the Fed's policies directly drive the stock market. We have the logical (get rid of yield on cash, money has to chase risk), the empirical (the charts and data), and all of the players admitting it. We also have the perverse: watch CNBC on Fed announcement days.
If that doesn't convince you, there's nothing that can.
(What I said was, "On the evidence you are presenting: This doesn't prove that the Fed is causing a stock bubble. The stock market, if anything, is forward looking. Even if the fed was causing a bubble, the kind of patterns you are showing wouldn't be expected. Take the second link, for example. The article clearly states that the stock price gains are made before the FOMC announcements. So somehow the act of making any announcement is causing the market to react in anticipation.
I don't know how to explain these patterns, but they are certainly not good evidence for the Fed causing a bubble.")
These are not the only stocks benefiting, but they're great examples.
> Providing easy money should give a boost to all stock prices...
I don't know when you last checked, but the S&P just hit a new all-time high this past week, and the Dow achieved a new all-time high last month. The NASDAQ is within striking distance of 4,000, a level last seen in 2000. So yes, easy money has boosted all stock prices.
> ...in fact the Feds actions should give the biggest boost to low risk investments since they are the closest substitutes for what the Fed is buying.
No, that is not how this works. The Fed's actions encourage (if "force" is too strong a word for your liking) investors to bid up riskier assets because it's damn near impossible to find returns anywhere else.
Furthermore, it's very hard to separate the direct effect of low interest rates, from improvements in the economy in general. You cite the current price of stocks as an example, but the Fed has had low interest rates since the financial crisis, so you to explain why now in particular is a bubble caused by low interest rates.
On the final point, I am correct about the mechanics of which stocks benefit the most. Suppose instead of high risk stocks, low risk stocks, and bonds, we had apples, oranges and mandarins.
When the Fed buys lots of mandarins, it creates excessive demand for mandarins, and so the price increases. This causes people who were buying mandarins to buy oranges and apples, instead but the total demand for mandarins has still risen. We would expected the biggest price increases to be in mandarins, then oranges, and then apples.
Similarly the biggest price change is in the bond market (which the Fed effectively has complete control over), and then in low risk stocks, and then high risk stocks.
The effect you observe - people being driven from the low-risk to high risk markets by low interest rates - is ignoring the initial price increase that caused this shift.
You are wrong on this. That's your problem. A dollar today does not equal a dollar tomorrow. Those promising more dollars the day after tomorrow, and those promising a dollar tomorrow will see differential pricing.
Or at least, so the theory goes.
You are applying a model with fixed r, which is wrong because the current low interest rates are temporary.
Forget the interaction between interest rates and risk preference for the moment. Isn't it the case that if interest rates are certain to return to normal in 2 years, then the values of an investment that returns in 5 years, and an investment that returns in 2 years, will be equally affected by current low interest rates?
No, this is not true. The whole point is that R=R(r). Its just that the relationship is ~chaotic, not linear. And it gets messy as either r or R --> 0. The fact that preferences are recursive on (r) should not be a surpirse, but I don't think mainstream Economists generally go there.
On the topic of "temporary" vs Uncertain changes in (r), they are not the same. One is risk, the other is uncertainty. In general risk is priced a certain way (reasonably efficient), uncertainty is something you have preferences for (ie, you dont "price" it in the normal sense) and can only model indirectly in the first instance.[1]
[1] eg, http://economistsview.typepad.com/economistsview/2010/06/ris...
The general consensus just a few short months ago was that the Fed would start tapering in September. It did not happen. There are credible observers and market participants who not only believe that tapering is not coming any time soon but that the Fed's asset purchases will actually increase.
I don't necessarily agree, but I do believe that the Fed has positioned itself between a rock and a hard place, so I personally wouldn't make too many assumptions about timing and magnitude of increases or decreases in asset purchases.
> So yes, the market will discount investments that pay off in 1-2 years at a low interest rate. But since the low interest rates aren't expected to last, we shouldn't expect huge price increases for stocks whose investments will pay off in 5-10 years.
You make the mistake of assuming that investors are entirely rational. The empirical evidence clearly demonstrates that this is not the case. You should also consider that many (and perhaps the majority) of the participants in a good number of markets aren't really "investors" as most people define the term.
John Williams, the President of the SF Fed, recently addressed asset price bubbles in a presentation[1]. It is well worth a read, and I would point you to the following:
"For monetary policy, one implication of theories with endogenous asset price bubbles is that the time horizon over which policy affects the economy may be longer than typically thought. In particular, the policy response to cyclical movements in economic activity and inflation may have effects on investor beliefs and the behavior of asset prices that reach well into the future."
[1] http://www.frbsf.org/our-district/press/presidents-speeches/...