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Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner

05-May-2006
The Source, from Dr. Kim Zussman

Recently recalling the late 90's, with all the magazine covers sporting smiling tech CEOs, ads for online brokerages, and overheard waiting-room boasting about positions in Cisco, Amazon, and Broadcom. One scruffy fellow even used the words "due diligence" about his position in MSFT circa 2000; evidently something he read on TV. Which leads to many questions, including whether bubbles only form in liquids.

The recent two years in Southern California have been wetter than usual; last year second highest on record and this one not far behind. During frequent hillside forays, it is easy to see the result at all levels in the ecosystem. Flora is more abundant and lush than what is usual in semi-arid terrain. Heavy growth of sage and other scrub, grasses, and flowering plants impinge the trails, many plants carry odd fruit or berries, with the verdant hills more resembling forests of the deep south.

This lead to an explosion in the insect and helminth population: bees busy at flowers, beetles and flies zipping and darting, worms and caterpillars creeping and chewing. Vegetation and insects feed higher forms, including birds, rodents, and deer, with the short-gestation folk partying most. Rabbits, squirrels, and birds are busy everywhere, while rats and mice proliferate in hiding. The yard has enough food to support a scrub-jay nest near the house, filled with four fat chicks served by programmatically industrious mama and papa.

Reptiles too are booming. Ordinarily hidden snakes are now seen often (three Pacific rattlesnakes and a bull snake within one week). Human encounters with rattlesnakes are usually uncommon, since they hunt in the brush while hidden from the hungry red-tailed hawks circling silently above. But now there are so many serpents bulging onto over grown trails that hikers have to watch their steps more than the scenery.

So the effects of unusually plentiful liquidity has fed growth, and all the various species flourish. Are there historical effects which correlate with prior changes in Fed liquidity? To look at this, historic monthly effective Fed rates were used to calculate QTR/QTR* change in interest back to 1954, and this was taken as a proxy for water. A similar series of QTR stock returns was obtained using SP500 index monthly closes. Then multiple and step-wise regression was done to identify whether any lagged QTR change (i.e., lags of 1, 2, 3 Qtr) in Fed effective rate predicted stock QTR returns.

Turns out only the prior QTR change in Fed interest rate approached significant negative correlation with the subsequent change in stocks (T=-1.87, p=0.063); recently declining interest is slightly bullish for stocks.

* To include recent April showers, series was divided into 3-month periods, "QTR", counting back with April. Thus these are not calendar quarters. Here is the series.