Tonight's reading included [part of] Chapter 4, Analysis of Equity Investments: Valuation, by Stowe, Robinson, Pinto and McLeavey.

I say "part of" because the damn chapter is approx. 80 pages long. I originally picked up the book to read up ch. 5, Residual Income Valuation, but apparently got side tracked...

Anyways, Ch.4 briefly explains the Fed Model on pg. 202, and I figured with the recent yield curve inversion and heated debate regarding the future of the 10yr yield, that a few links revolving the model might be timely.

For the uninitiated, the Fed Model is simply the theory that, since interest rates are implicit in any DCF or market multiple, one can gauge the under/over valuation of the stock market by comparing it's earnings yield to a 10-year T-bond. So, you take the P/E for the S&P 500 and you flip the fraction or take the inverse to get E/P, and compare this to the 10-yr rate. If the treasury rate is higher (lower) than the earnings yield, then stocks are overvalued (undervalued).

• Daily Speculations Resource - Victor Niederhoffer & Laurel Kenner
  
• Summary of Clifford Asness Paper published in the Journal of Portfolio Management. A take away quote,"The crucible for testing a valuation indicator is how well it forecasts long-term returns, and the Fed Model fails this test..."
  
• The Street's piece, "The Fed Model Impels, but Does Not Compel"
  

On a side note, I came across a great Federal Reserve Board of NY Q&A on inversions, titled, "The Yield Curve as a Leading Indicator"

As far as the fed model goes, I don't think anyone truly believes it is anything more than a back of the envelope metric to view the market valuation in another light. Besides, it is also a relative measure which doesn't save you if both treasury bonds and the market are due for a correction, or vice versa.

Good Night

Mr. Risky Returns