Oliver Wyman unveils new stock market model

29 October 2021 Consulting.us 2 min. read

Oliver Wyman Forum, the management consultancy’s research and leadership community, has unveiled its new Holistic Market Model (HMM) that attempts to more accurately explain the performance of the US stock market over the past 150 years.

The new research, which Oliver Wyman Forum says is “the most comprehensive analysis of the US stock market ever developed,” was led by Jacques Cesar, a former managing partner of Oliver Wyman. It combines finance, accounting, analytics, economics, history, and sociology to explain the stock market's ups and downs over the past 150 years more accurately than previous models.

The HMM explains why stock prices have behaved the way they have over the past 150 years, while also providing a new paradigm to deal with future uncertainty. The graph below shows the equity model’s excellent fit.

The HMM can help forecast how changes in inflation, taxation, interest rates, and income inequality could determine future market levels, according to Oliver Wyman.

Oliver Wyman’s Holistic Market Model of S&P 500 real price per share 2020 $, January 1871–June 2021

The HMM is a combination of a re-engineered capital asset pricing model (CAPM) and a new supply/demand balance model. According to Oliver Wyman, the CAPM – which attempts to explain the relationship between systematic risk and expected return for assets (including stocks) – works in theory but not in practice. This shortfall stems from execution deficiencies rather than a fundamental conceptual issue. However, the CAPM can be salvaged if it is re-engineered by subtracting inflation expectations and using the real truly risk-free rate (RTRR) as its root, says the research.

The other part of the HMM is a supply/demand balance model that explains annual equity prices well using only 19th century economic tools based on supply and demand.

“This work exemplifies Oliver Wyman’s ability to create breakthroughs in the most challenging problems facing business, finance, and society,” said Nick Studer, president and CEO of Oliver Wyman.

Over the next several months, Oliver Wyman Forum will release a series of five white papers delving into the research and its insights into market behavior.

Among the research’s notable findings is that equity market valuations just before the pandemic were elevated but not extreme. In contrast, 2021 cyclically-adjusted price-earnings multiples (CAPE)-based evaluations were very high. However, Oliver Wyman notes that these valuations were broadly commensurate with unprecedentedly low interest rates and below-average risk aversion.

The research also reconstructed sales per share of the S&P 500 Index back to 1871 and found that secular profit margins before corporate taxes are near an 80-year high, the combined corporate and investor personal tax rate is near an 80-year low, and secular post-all-tax margins are near a 100-year high.