Investing Research Articles

…the Fed model and the long-term P/E mean reversion model are complementary perspectives on return prediction, with the former reasonably useful for forecasting up to three years into the future and the latter applicable over longer horizons.

The guiding belief of the Fed Model of stock market valuation is that investors use a Treasury note (T-note) yield as a benchmark for the expected (forward) earnings yield of the stock market. When the gap between the forward earnings yield and the T-note yield is positive (negative), stocks are relatively attractive (unattractive), and investors… Keep Reading

Is there a way to restore/enhance the relevance to investors of the Fed model, which is based on a putative investor-driven positive relationship between stock market earnings yield (equity earnings-to-price ratio) and U.S. Treasury bond (10-year) yield? In his February 2023 paper entitled “The Fed Model: Is it Still With Us?”, David McMillan re-examines the… Keep Reading

Is there a better way than the Fed model to measure relative attractiveness of equities and bonds. In his October 2020 paper entitled “Towards a Better Fed Model”, Raymond Micaletti examines seven Fed Model alternatives, each comparing a 10-year forward annualized estimate of equity returns to the yield of 10-year constant maturity U.S. Treasury notes… Keep Reading

…the Fed Model better describes the behavior of the market P/E over the past forty years than does a mean-reverting model.

…practitioners who use the Fed Model are simpletons. The model is theoretically implausible and empirically challenged.

Can investors rely on overvaluation signals from the market price-earnings ratio (P/E) and the Fed Model to predict major stock market corrections? Which model works better? In their July 2013 paper entitled “Does the Bond-Stock Earning Yield Differential Model Predict Equity Market Corrections Better Than High P/E Models?”, Sebastien Lleo and William Ziemba test the power of… Keep Reading

…the Fed Model is inferior to fundamental valuation in predicting long-term stock returns, but it may have some tactical value.

The Fed Model relates the aggregate earnings yield (E/P) of the stock market to Treasury bond or bill yields under the assumption that investors view equities and government bonds as competing ways to achieve yield. Might supply (company management), rather than demand (investors), more precisely drive the relationship between E/P and interest rates? In the… Keep Reading

…the Fed Model has worked pretty well starting about 1960, with interest rates since playing a key role in stock valuation.