If the Fed Model Suggests that Stocks are Cheap, Shouldnt I Back the Market?
The so-called Fed Model attempts to value shares relative to nominal bond yields. There is no justification for this either in theory or practice. (Report No. 133 The Myth of Yield Ratios. 10th May, 1999.) Whatever your view about the abilities of the Federal Reserve, it would be slanderous to lay the blame for the Fed Model at their door. In Report No. 133 we showed that the observed positive correlation between dividend and earnings yields on shares and the yield on bonds applied only in the US from 1977 to 1997. It has not applied since. Furthermore, there was a marginally stronger negative correlation from 1948 to 1968 and no long-term relationship whatever. The bond yield myth is thus an egregious example of data mining.
