Why Are You Still Watching the Fed?

Following two days of losses instigated by the Cypriot debacle (which is ongoing), the market's focus shifted to the outcome of the Fed's rate-setting meeting today. Stocks rebounded, with the S&P 500 gaining 0.7%, while the narrower, price-weighted Dow Jones Industrial Average rose just 0.4%.

Consistent with those gains, option traders pushed the VIX Index , Wall Street's "fear index," down 12% to close at 12.67. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.) As of this afternoon's close, the evidence suggests that U.S. investors have all but forgotten Cyprus and the eurozone's woes and the incident will barely register on the itinerary of this bull market. Mind you, we have yet to establish a new all-time (nominal) high in the S&P 500, so all is not won yet.

Nothing to see here, folks
One can only marvel at the amount of effort that professional investors and analysts expend on tracking, analyzing and forecasting the Fed's behavior, to the point where it has spawned its own industry of Fed watchers. I'm on the fringe of that circus -- it's an occupational hazard.

I wish I could say this fixation is entirely irrational and unproductive, but that wouldn't be true. After all, in a paper published in Sept. 2011 and revised last June, two staff members of the Federal Reserve Bank of New York found that four-fifths of the U.S. equity premium earned since 1994 was due to abnormal excess returns generated in the 24-hour window prior to Federal Open Market Committee announcements (such as today's.) Four-fifths!

Still, the fact that the bulk of the premium was realized during those periods does not imply that the Fed somehow generated it. Over the long term -- and a 17-year span starts to qualify -- real equity returns are the product of earnings growth, companies' allocation of those earnings and stocks' initial valuation -- and no other factor.

If your time frame is measured in hours, days, or months, following the Fed is a necessity. On the other hand, if it is measured in years -- the equity-appropriate time unit -- you're much better off focusing on the three factors I identified above. Oh, and if you were wondering, there was zero change to Fed policy today -- the statement was virtually identical to January's.

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The article Why Are You Still Watching the Fed? originally appeared on Fool.com.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned, and neither does The Motley Fool. You can follow Alex on LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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