Tip for Fed / Yardeni Model (over/undervalued)

CFA Level III
#1

Not sure if I was the only one who kept missing these questions, but I thought I would share this because I could never get this right wit how others explained it… I think it works all the time… indecision

If the question is asking if the equity market is over / under valued just look at it as (numerator / denominator)

comparing the numerator (equity market = E1/P0) relative to the denominator.

If the numberator has a higher yield it means you want to buy it because it it’s a good deal (undervalued) . If the yield is lower than the denominator why would you want the lower yield? you don’t want stuff that’s overpriced relative to the denominator (10 Yr Bond or Yardini).

#2

What you want to look at is the denominator (for simplicity).

Since equilibrium requires the EY to equal the 10yr bond yield, a low EY (compared to 10 yr by) would have to adjust upwards, meaning a decrease in P, meaning that P is currently overvalued.

#3

your way of thinking is CFAI thinking :smiley: mine is for the simple minded that use the average joe language haha.

but ya that would be consistent with how we look at interest rate movements.

#4

take the reciprocal ( 1/n )

this is the P/E ratio.

compare to P/E ratio of the market (1/Yield)

as always, p/e less than market = undervalued

#5

I always think of it as the earnings are the same for the index/treasury so the price must be adjusted to make the ratio equal.

For example if the raito in the fed model is > 1 then the index price must be adjusted upward to make the ratio 1 so the index must be undervalued.

#6

Why is this easier than remembering > 1 = undervalued?