WILL WE REVISIT THE 666 LOWS?
Nice piece of research out of Kanundrum Research yesterday. Using past Fed Model data, they conclude that the market will not retest its 666 low:
As a refresher, the term “Fed Model” was coined by Ed Yardeni when he referenced research the Federal Reserve conducted on the equilibrium between the yield on 10 year Treasuries and the earnings yield of the S&P 500 index. Simply stated, the Fed model suggests that the yield on 10 yr Treasuries should be equal to the earnings yield on the S&P 500. The earnings yield is simply the P/E ratio upside down or earnings divided by price.
While rarely at “equilibrium” the Fed model can be used to compare the relative value of Treasuries to equities. When the earnings yield on the S&P 500 is greater than the 10 year yield, the Fed model suggests investors should sell Treasuries and buy Equities. The difference between the yields is referred to as the risk premium. We used the data from Robert Schiller to construct the risk premium from 1881 to 2009.
The yellow highlighted circles represent periods of extreme risk premiums, that is to say a “peak” in
risk premium. Since 1881 there have been 10 major peaks in risk premium; 9 out of the 10 peaks
resulted in a major market rally at the 3, 6 and 12 month time horizon. The peaks and subsequent S&P 500 returns are presented in the table below.
It is clear to see that with the exception of the December 1920 peak, the S&P 500 experienced significant appreciation over the next 3, 6 and 12 months. The accuracy and subsequent rise in the S&P 500
requires our undivided attention to this indicator. Since the March 2009 peak in risk premium the
S&P 500 has risen 34.44%. Based on historical evidence we would expect the S&P 500 to continue its rise over the next 9 months.Interestingly, the period that experienced the largest percentage gain was 1932-1933. The resemblance of today’s markets to that period is uncanny. What’s more is 1932-1933 was the only period in which the 6 month return was less than the 3 month return. This fits with our technical take that the current leg up was the first 1/3 of this correction within a bear market. Furthermore, this would suggest the downtrend that began on June 11th will not break the March 2009 lows.
Interesting data. Personally, I have never really bought into the Fed Model for valuing stocks or bonds. As regular readers know, I am skeptical of any valuation metric that involves the estimates of the analyst class on Wall Street. They have been horribly wrong throughout this crisis and will likely continue to do so. Using a metric such as this that involves 1 part guesses has to be questioned. Although the findings are convincingly positive, I have to call this nothing more than a fancy piece of coincidental datamining.
Source: Kanundrum Research
You refer to the possibility of a “a fancy piece of coincidental datamining”. I agree. Who can say if the little “peak is really such or the beginning of a much higher peak in the future? Actually the 2009 “datapoint”, as graphed, may only be the beginning of a peak in the risk premium that will occur (say) next year at a much higher level – comparable to those in 1920 and 1932…
If I understand correctly, if (OK, when) the earnings “estimates” turn out to be wrong & too high, then the “risk premium” will turn out to have been wrong & too high.
Gee, where’s the risk in that trade?
“The Fed model suggests that the yield on 10 yr Treasuries should be equal to the earnings yield on the S&P 500.”
Let me get this straight. If government notes yield 3.5%, then the “correct” P/E ratio for the market is 28.6?
Well, nice to see that we’ve debunked this piece of research….
Dr. Hussman has roundly trounced the Fed Model of valuation, as you probably are aware TPC. There’s an article in his archives that can be searched out.
This is just more of the rationalization of higher P/E multiples from the height of the great bull market, and will die eventually as this secular bear grinds on, IMO.
Hadn’t seen that Onlooker. I’ll look into it. I always have trouble believing anything that is based on analysts estimates. If it weren’t for them I’d be out of business….
I’m thinking that we will not hit it either. As long as we can get away with printing money and issuing massive debt – the Fed can just flood the market with more liquidity.
Whenever that time comes where there is a “significant event” to this model is when things will start to fall apart.
What’s the P/E for the S&P 500?? I thought it is about 100 now.
I do think dividend yields have to be higher to conpensate for the potential of downward volatility. Yields have to go higher in order to attract long term investors.
MARKET QUOTES
THIS WEEKS MOST POPULAR STORIES
MARKET NEWS
© 2009 pragcap.com · Login.
Home · Advertise · Contact us · Disclaimer ·