list some limitations to it and/or times when it tends to break down. GO.
interest rate is very low then it distort the relationship ignore equity premium inflation growth opportunity
You’re comparing a nominal yield to a real yield
- ignore the earnings growth 2) treasury bond yield is nominal while the earnings yield is in real term. 3) not considering equity risk. don’t know when it breaks down…definitely not working in the recent crisis.
and if the Fed Model= 4 and the SP earnings yield is 7, do you buy stocks or short em? huh huh?
Buy!
nice work! LIMITATIONS: 1. ignores equity risk premium 2. ignores earnings growth 3. compares a real variable to a nominal variable BREAKDOWN: - when inflation is very low - when consumer prices are stagnant and deflation threatens (relationship b/t stock market valuation and bond yields becomes ambiguous)
wait, if the market says 7% yield and the model only says 4%, wouldn’t you want to short equities thinking that they’re overpriced? have i been studying too long and need a break?
nah remember this calculates the equilibrium yield. i cant find a way to logicaly remember this so I just remember this as being one of the few times where if the SP yield is higher than the FEd, it means invest in the SP because they are undervalued. go figure. edit: banni no offense but i thought you were an indian dude for some reason.
hmm, ok. i guess i can talk myself into that making sense… so i have some stock that should yield me 4% and yields me 7%… winner, i’ll take it! i’m sure someone smart here can tell me the real reason why this is. i thank you SkipE for adding this and i will nail it on exam day if it’s a simple q like that giving the 2 #'s.
haha skipE, now you know that isn’t even close to true! i’ve met pinkman before, so he knows it’s not true either. the rest of you can think whatever you want.
i think of this one in present terms…the FED is offering you 0% on your money market so invest in S&P with yield of 2%+ b/c they are deemed undervalued
if stock yields are very high versus bond yields that must mean stock prices have fallen for the yields to rise and likely that bond yields have fallen and the prices rose making equities cheap and bonds rich. or something!
OK. Example. S&P Earnings Yield = 7% Treasury Yield = 4% S&P 500 Index = 1000 (for simplicity’s sake) S&P 500 Index Earnings = 70 The Fed Model assumes that the S&P Earnings Yield is equal to the Treasury Yield. Thus: .04 = 70 / X Solve for X X = 1750 S&P 500 is therefore undervalued. Time to buy.
bannisja Wrote: ------------------------------------------------------- > haha skipE, now you know that isn’t even close to > true! i’ve met pinkman before, so he knows it’s > not true either. the rest of you can think > whatever you want. I think you are alien… I am not Indian but is there anything wrong with being one?? Eh?
no nothing wrong at all! my best friend is indian, i went to india for 2.5 weeks this past xmas/new year. love it. i am an alien to most CFA studiers… aka of the XX chromosome.