Fed Yardeni and CAPE

CFA Level III
#1

Does anyone have a good explanation on the direction of these ratios? Can’t for the life of me figure them out. Like when it’s over/undervalued etc

#2

Fed Model = S&P Earnings Yield / 10 Year Treasury

  • S&P Earnings Yield = Earnings/Price (E/P) – think of bond yields - when the yield is high, price is low.

-So, when the Fed Model provides a number > 1, that means that the S&P earnings yield is higher than the current 10 year treasury yield, meaning that stocks have sold off (high yield, low price) and that the stock market is undervalued and should be bought.

CAPE - Stock Market Price / 10 year inflation-adjusted earnings

  • This is more of your simple P/E ratio where the lower the ratio is, the cheaper the stock market. You typically compare the CAPE ratio to what it was historically, however there are certain issues identified with the model where, while helpful to see the current valuation, make the model less useful for current valuations.
#3

Exactly what Rpearce said. Think of the yields as E/P, when they’re high, the relative prices of stocks are low. When the yields are low, the relative prices of stocks are high.

#4

Thank you guys! Exactly what my confusion was - Earnings relationship is opposite to P/E, high yields -> low price -> underpriced. Thank you!!