Dec
4
Fed Model, from Henrik Andersson
December 4, 2007 |
Apparently the earnings yield for the S&P 500 12M forward compared to the 10Y bond interest rate is at a 25 year high at a little less than 350 basis points…
Rob Rice objects:
The Fed model is both overly simplistic and frequently wrong as a basis for accurate valuation of equities versus bonds, except during infrequent, cherry-picked points in time. It’s also inappropriately named. Those sound bites will get you every time.
Victor Niederhoffer replies:
The Fed model Laurel and I developed is completely operational, completely predictive, and accurate to an extraordinary sense. It's based on a I/B/E/S operational earnings forecasts contemporaneously made at the beginning of each year as of the time (the same results from Value Line) and has nothing to do with the accuracy of the earnings prediction. It has to do only with the differential, and when the differential is this high, the average returns is about 20% one year forward, and it's been right 10 of the last 10 years.
Barry Gitarts writes:
CXO Advisory uses a variation
of the Fed Model. According to them the spread
between the S&P E/P and total inflation is more significant then
using T-notes as the benchmark for S&P forward yield. A possible
interpretation is that most equity investors do not closely track
T-notes as competing investments, and that they instead focus on the
"real earnings yield" of stocks in deciding whether to buy, hold or
fold.
This may be the case, but it seems to me the bond market is more forward
looking than the CPI.
Comments
3 Comments so far
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I only just learned about the earnings yield and how it relates to the bond yield about 3 weeks ago. Prior to that, this post would have meant nothing to me. Correct me if I’m wrong, but when the earnings yield is higher than the bond yield, it means that stocks are cheap relative to bonds, right?
http://en.wikipedia.org/wiki/Fed_model
what is your fwd earnings assumption?