Modeling the S&P 500 with the Fed’s New Monetary Policies

Since order has broken down for the S&P 500 (Index: SPX), the past week has proven to be challenging for projecting the future for the index.

Here's an example of what we mean. The following chart illustrates the dividend futures-based model's alternative projections keeping all the same basic assumptions we've been using since 16 June 2021.

Alternative Futures - S&P 500 - 2022Q1 - Standard Model (m=-2.5 from 16 June 2021) - Snapshot on 28 Jan 2022

Going by this chart, the S&P 500's trajectory has fallen below the bottom end of the range we would expect if those assumptions still held.

But since this situation developed shortly before the Federal Reserve's Federal Open Market Committee's 25-26 January 2022 meetings, we have a unique opportunity to adjust the assumptions behind the model. That's because these meetings give us additional information we need to calibrate the model.

In this case, the additional information tells us exactly how far into the future investors are focusing their forward-looking attention. Thanks to the Fed's announced plan to accelerate the tapering of its purchases of treasuries that have been stimulating the U.S. economy and to start hiking short term interest rates, we confirm that investors are closely focused on the current quarter of 2022-Q1.

The announced change of monetary policies affects the dividend futures-based model by changing the value of m, the simple multiplier used in the model. The next chart shows the results we obtained when we matched the alternate future trajectory associated with investors focusing their attention on 2022-Q1 with the level of the S&P 500 on 26 January 2022 when the Fed officially announced its new monetary policy plans.

Alternative Futures - S&P 500 - 2022Q1 - Standard Model (m=-5.0 from 26 January 2022) - Snapshot on 28 Jan 2022

With a sample size of just three trading days since that event, it's still too early to tell if that will be a sufficient adjustment. The initial results are promising but we'll need many more days of trading to properly assess the model's performance.

In any case, our next calibration opportunity will come with the FOMC's next meeting six weeks from now. In between now and then, we'll have the random onset of new information to tell us how the model's multiplier might need to be adjusted. Here are the headlines that caught our attention for their market-moving potential, where we see the outsize role of the Fed in setting investor expectations and forward-looking focus during the past week.

Monday, 24 January 2022
Tuesday, 25 January 2022
Wednesday, 26 January 2022
Thursday, 27 January 2022
Friday, 28 January 2022

As of the close of trading on 28 January 2022, the CME Group's FedWatch Tool projects quarter point rate hikes in March 2022 (2022-Q1), May 2022 (2022-Q2), June (2022-Q2), July (2022-Q3), and December (2022-Q4), making five rate hikes during 2022. The FedWatch tool also projects quarter point increases in March 2023 (2023-Q1) and July 2023 (2023-Q3).

Then again, the Atlanta Fed's GDPNow forecasting tool is projecting a near 0% real growth rate for GDP in the current quarter of 2022-Q1, which would bring the Fed's rate hiking plan and the expectations related to it into question.