Interest Rates/Stock Market

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lev

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Fact: Since about 2003 the 60-month correlation coefficient between the Long-Term Bond Yields and the Stock Market performance has been positive. For those of you who have not been touched by the news, I repeat - INTEREST RATES AND SECURITY PRICES ARE POSITIVELY RELATED (it turns out).

I think DDM has just been executed.



Edited 2 time(s). Last edit at Thursday, June 29, 2006 at 04:45PM by lev.
 
Can you explain why?? I have an idea but I think its a little....ummmmm, uninformed..

Its not the asset preference theory.
 
Hi,
If im not wrong isnt dividend/(r-g) the formula for DDM??
r = int. rate
g= growth rate
 
Since the bull run from 2003, money has moved out of bonds (increasing the yield) and into stocks. Growth has outpaced long term interest rates. What's the opposite of stagflation?
 
I don't think anyone's going to dispute "the market is wierd right now".

It's wonderful that there's a positive correlation with a single bond on a single average over a 3 year timespan, but I'm not sure I'd let that alone "discount" (get it? DISCOUNT!!) a well established and proven model.

I also think it'd be silly to expect a model with only 3 independent variables to be accurate in the real world all the time.
 
Since bonds are losing value wouldn't it be smart to put your money into something else?? If people are dumping bonds wouldn't it lower financial leverage and increase profitability??
 
On a more serious note...

The DDM simply says that a stock's value is the present value of future cash flows from the stock. This really isn't something that can be disproved. The value of any financial asset is the present value of future cash flows from the asset. It's just a useless formula for anything except conveying some broad understanding of why someone might want to own stocks or something. It doesn't have anything to do with the correlation between long-term bond yields and stocks.

I think that long-term bond yields are overly tied to Fed action and for the last several years, the market has believed that the omniscient Fed can foresee economic growth and react preemptively to avoid all the evils of unrestrained economic growth. The Fed tightens and the bond market tightens 10 years from now. The stock market is reacting to the same kinds of things the Fed is, so the correlation is natural. Now whether this keeps going is an entirely different question....
 
2 notes here: K = RFR + IP + Risk Prem. RFR tends to be reasonably stable compared to the risk premium and the Inflation premium as an economy reaches it's peak, #2 bond yields interest levels which are based upon how tight the Fed constricts MS, based upon the Fed's belief of how much a threat inflation poses. Also note that as an economy gets more and more heated, the stock market will see gains and bond yields will increase as interest is jacked up. The inverse is true as well; as the economy, slows inflation dips, the fed loosens MS & Interest rates fall ==> yields fall, equity prices will fall as well, in general as the market dips.

According to the DDM, G is a bigger factor, as K increases based upon higher RFR and Inflation prem, G will also increase at a greater rate (lowering the denominator) and the Risk Premium, also implicit in K will decrease (also decreaseing K and the denominator). As the increase in G will have a greater impact for a company it's stock, Stock prices will increase.
 
The correlation is clearly not 1 to 1.

However, there have been articles written recently about how many assets that were once seen as negtatively correlated or not correlated that now show to have some small amount of correlation.

This is no great surprise. With the globalization of markets this was bound to happen. However, DDM is still alive and well.
 
Lev, is the correlation statistically significant? t=........ouch my head hurts.
 
Don't know. It was published by one of IM firms without much detail.



Edited 1 time(s). Last edit at Friday, July 7, 2006 at 11:02AM by lev.
 
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