Fed model hypothesis
This theory holds that the stock market, at any given point in time is undervalued whenever the earnings yield on equities, which is the inverse of the P/E ratio, is higher than the yield on the 10-year Treasury bond, which is used as a gauge of investors’ expectations for long-term inflation.
Data over the past 150 years, however, reveals that the earnings yield by itself is a more accurate predictor of the stock market’s future return than earnings yields adjusted by the prevailing 10-year Treasury yield. This data shows there is little historical support for the predictive power of the Fed model.
