Equities
Fight the Fed Model
September 1, 2003
Topics - Equities Asset Allocation
Strategists, portfolio managers and market pundits often claim that the high market multiples of the early 2000s were justified by low interest rates and/or inflation.
The most widespread version of this comparison of stocks to bonds is often deemed the Fed model. This model, allegedly found in the annals of a Fed report (not named because of any official Fed endorsement), comes in various forms, but generally asserts that the stock market’s earnings yield should be compared to current nominal interest rates (the earnings yield, or E/P, is the inverse of the well-known price-to-earnings ratio or P/E).
This has the appearance but not the reality of common sense. The empirical evidence tells us the Fed model has no power to forecast long-term real stock returns. On the contrary: Traditional methods, like examining the market’s unadjusted P/E alone, have been very effective.
In the end, we believe the Fed model is a misleading sales tool for stocks. Its popularity is presumably driven by its simplicity; its flexibility (if you don’t like the E/P, just call some expenses non-recurring); its superficial rigor (it looks like math); its false initial resemblance to common sense (pundit after pundit enjoys explaining to a presumably impressed audience how bonds really have a P/E too); and most assuredly the fact that it is now, and for some time has been, more bullish than the traditional model.
This document is not intended to, and does not relate specifically to any investment strategy or product that Lodestone Wealth offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein.
This document
has been provided to you solely for information purposes and does not constitute an offer or
solicitation of an offer or any advice or recommendation to purchase any securities or other
financial instruments and may not be construed as such. The factual information set forth herein
has been obtained or derived from sources believed by the author and Lodestone Wealth Management
LLC (“Lodestone Wealth”) to be reliable but it is not necessarily all-inclusive and is not
guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express
or implied, as to the information’s accuracy or completeness, nor should the attached
information serve as the basis of any investment decision. This document is not to be reproduced
or redistributed to any other person. The information set forth herein has been provided to you
as secondary information and should not be the primary source for any investment or allocation
decision. Past performance is not a guarantee of future performance. Diversification does
not eliminate the risk of experiencing investment losses.
This material is not research and should not be treated as research. This paper does not
represent valuation judgments with respect to any financial instrument, issuer, security or
sector that may be described or referenced herein and does not represent a formal or official
view of Lodestone Wealth. The views expressed reflect the current views as of the date hereof
and neither the author nor Lodestone Wealth undertakes to advise you of any changes in the views
expressed herein.
The information contained herein is only as current as of the date indicated, and may be
superseded by subsequent market events or for other reasons. Charts and graphs provided herein
are for illustrative purposes only. The information in this presentation has been developed
internally and/or obtained from sources believed to be reliable; however, neither Lodestone
Wealth nor the author guarantees the accuracy, adequacy or completeness of such information.
Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be
relied on in making an investment or other decision. There can be no assurance that an
investment strategy will be successful. Historic market trends are not reliable indicators of
actual future market behavior or future performance of any particular investment which may
differ materially, and should not be relied upon as such. Diversification does not
eliminate the risk of experiencing investment losses.
The information in this paper may contain projections or other forward-looking statements
regarding future events, targets, forecasts or expectations regarding the strategies described
herein, and is only current as of the date indicated. There is no assurance that such events or
targets will be achieved, and may be significantly different from that shown here. The
information in this document, including statements concerning financial market trends, is based
on current market conditions, which will fluctuate and may be superseded by subsequent market
events or for other reasons.