Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
Gold Price Closely Tracks Debt-to-GDP Ratio - 9th Apr 20
Gold, Silver and Rigged Market Socialism - 9th Apr 20
Going to School in Lockdown Britain, Dobcroft Sheffield - 9th Apr 20
Amazon Face Masks to Protect Against Covid-19 Viral Particles N95, FPP2, PM2.5, for Kids and Adults - 9th Apr 20
Is Natural Gas Price Ready For An April Rally? - 8th Apr 20
Market Predictions And The Business Implications - 8th Apr 20
When Will UK Coronavirus Crisis Imrpove - Infections and Deaths Trend Trajectory Analysis - 8th Apr 20
BBC Newsnight Focuses on Tory Leadership Whilst Boris Johnson Fights for his Life! - 8th Apr 20
The Big Short Guides us to What is Next for the Stock Market - 8th Apr 20
USD Index Sheds Light on the Upcoming Gold Move - 8th Apr 20
The Post CoronaVirus New Normal - 8th Apr 20
US Coronavirus Trend Trajectory Forecast Current State - 7th Apr 20
Boris Johnson Fighting for his Life In Intensive Care - UK Coronavirus Crisis - 7th Apr 20
Precious Metals Are About To Reset Like In 2008 – Gold Bugs, Buckle Up! - 7th Apr 20
Crude Oil's 2020 Crash: See What Helped (Some) Traders Pivot Just in Time - 7th Apr 20
Was the Fed Just Nationalized? - 7th Apr 20
Gold & Silver Mines Closed as Physical Silver Becomes “Most Undervalued Asset” - 7th Apr 20
US Coronavirus Blacktop Politics - 7th Apr 20
Coronavirus is America's "Pearl Harbour" Moment, There Will be a Reckoning With China - 6th Apr 20
Coronavirus Crisis Exposes Consequences of Fed Policy: Americans Have No Savings - 6th Apr 20
The Stock Market Is Not a Magic Money Machine - 6th Apr 20
Gold Stocks Crash, V-Bounce! - 6th Apr 20
How Can Writing Business Essay Help You In Business Analytics Skills - 6th Apr 20
PAYPAL WARNING - Your Stimulus Funds Are at Risk of Being Frozen for 6 Months! - 5th Apr 20
Stocks Hanging By the Fingernails? - 5th Apr 20
US Federal Budget Deficits: To $30 Trillion and Beyond - 5th Apr 20
The Lucrative Profitability Of A Move To Negative Interest Rates - Pandemic Edition - 5th Apr 20
Visa Denials: How to avoid it and what to do if your Visa is denied? - 5th Apr 20 - Uday Tank
WARNING PAYPAL Making a Grab for US $1200 Stimulus Payments - 4th Apr 20
US COVID-19 Death Toll Higher Than China’s Now. Will Gold Rally? - 4th Apr 20
Concerned That Asia Could Blow A Hole In Future Economic Recovery - 4th Apr 20
Bracing for Europe’s Coronavirus Contractionand Debt Crisis - 4th Apr 20
Stocks: When Grass Looks Greener on the Other Side of the ... Pond - 3rd Apr 20
How the C-Factor Could Decimate 2020 Global Gold and Silver Production - 3rd Apr 20
US Between Scylla and Charybdis Covid-19 - 3rd Apr 20
Covid19 What's Your Risk of Death Analysis by Age, Gender, Comorbidities and BMI - 3rd Apr 20
US Coronavirus Infections & Deaths Trend Trajectory - How Bad Will it Get? - 2nd Apr 20
Silver Looks Bearish Short to Medium Term - 2nd Apr 20
Mickey Fulp: 'Never Let a Good Crisis Go to Waste' - 2nd Apr 20
Stock Market Selloff Structure Explained – Fibonacci On Deck - 2nd Apr 20
COVID-19 FINANCIAL LOCKDOWN: Can PAYPAL Be Trusted to Handle US $1200 Stimulus Payments? - 2nd Apr 20
Day in the Life of Coronavirus LOCKDOWN - Sheffield, UK - 2nd Apr 20
UK Coronavirus Infections and Deaths Trend Trajectory - Deviation Against Forecast - 1st Apr 20
Huge Unemployment Is Coming. Will It Push Gold Prices Up? - 1st Apr 20
Gold Powerful 2008 Lessons That Apply Today - 1st Apr 20
US Coronavirus Infections and Deaths Projections Trend Forecast - Video - 1st Apr 20
From Global Virus Acceleration to Global Debt Explosion - 1st Apr 20
UK Supermarkets Coronavirus Panic Buying Before Lock Down - Tesco Empty Shelves - 1st Apr 20
Gold From a Failed Breakout to a Failed Breakdown - 1st Apr 20
P FOR PANDEMIC - 1st Apr 20
The Past Stock Market Week Was More Important Than You May Understand - 31st Mar 20
Coronavirus - No, You Do Not Hear the Fat Lady Warming Up - 31st Mar 20
Life, Religions, Business, Globalization & Information Technology In The Post-Corona Pandemics Age - 31st Mar 20
Three Charts Every Stock Market Trader and Investor Must See - 31st Mar 20
Coronavirus Stocks Bear Market Trend Forecast - Video - 31st Mar 20
Coronavirus Dow Stocks Bear Market Into End April 2020 Trend Forecast - 31st Mar 20
Is it better to have a loan or credit card debt when applying for a mortgage? - 31st Mar 20

Market Oracle FREE Newsletter


Stock Market Indicator Says Stocks Should Double

Stock-Markets / Stock Markets 2013 Apr 01, 2013 - 12:15 PM GMT

By: Money_Morning


Martin Hutchinson writes: With the markets breaking all-time highs last week, it begs the question of just how high they can go.

At 1,569 points the bears would say at this point the S&P 500 is completely overdone. With a sluggish economy and a growing federal deficit, you might be prone to believe them.

But there is a little-known indicator that became very fashionable between 1982-2007 that says something else entirely. Noted for its accuracy over that period, it actually suggests that stocks should double.

It's called the "Fed Model."

It's based on a principle that the earnings yield on the Standard and Poor's 500 index should be the same as the yield on the 10-year Treasury bond.

Using today's trailing four quarters of S&P 500 earnings of $85.39 and 10-year Treasuries yielding 2.03%, the model gives a value for the index of 4,206 -- well over double the current figure.

How Accurate is the Fed Model Today?
Of course, stock market valuation models are an attempt by market fundamentalists to figure out where the market should trade, and whether they should be buying or selling at a given moment.

When I was in business school, we were taught that the value of a stock was the discounted present value of its stream of dividends.

By that standard, the Fed model is over-generous. It assumes that all earnings have full value to investors, whether they are paid out as dividends or not.

It also assumes that you discount at the 10-year Treasury bond rate, without taking account of the greater risk stocks pose in relation to bonds. On the other hand, it doesn't take into account that stocks offer greater protection against inflation compared to bonds.

Most of the time, the "Fed model" gives a valuation that is rather above the market's normal trading level - this is why it became so attractive to Wall Street analysts, most of whom are fundamentally in the business of selling stocks.

On a historical basis, The Fed Model tracked the market's actual performance pretty well for a period of 25 years, enough to make it a cherished icon on Wall Street.

But that could be coincidental since between 1982-2007, interest rates began at a very high rate and then declined steadily, while stocks rose.

Here's what we do know: After 2007, the Fed Model went spectacularly wrong. Interest rates were forced down by Ben Bernanke, so the Fed Model valuation of the market rose.

However, the exact opposite happened and the market fell out of bed. Admittedly, right at the bottom, in the fourth quarter of 2008, the earnings on the S&P 500 index were negative mostly because of the big bank write-offs. But the earnings recovery came quickly and interest rates stayed very low, even falling further.

So there's a Ben Bernanke-inspired mismatch that the Fed Model gives a stock market valuation more than twice the current level.

The Fed Model As a Crystal Ball
As suggested above, I believe the Fed Model is only right by accident. However, lots of people follow it, and they have a hell of a lot more money than I do.

That means there's currently a strong force pushing the market up towards the Fed Model valuation, which may well get stronger now that the market has hit new highs and is climbing into new territory.

That means either stocks have to rise a lot, or interest rates do.

In what looks to me like the first gentle downward slope in a big bear market for bonds, interest rates are already gently rising. Of course, Ben Bernanke is buying $85 billion of long-term Treasury and mortgage bonds each month, pushing the market further and further from where it naturally wants to go.

Even though the U.S. economy is looking a bit stronger and inflation is showing signs of ticking up, I still believe Bernanke will strongly resist any call to raise short-term rates, or even to stop buying bonds.

That will increase the upward push on the stock market. Even if bond yields go on rising gently so that the 10-year Treasury yields 3%, the Fed model would still give a valuation of 2,846 for the S&P 500 index.

That's why I don't think the S&P 500 index will make it to 4,206. But I do think it might get as far as 2,494, which matches the peak of March 24, 2000 (1,527) adjusted by the rise in nominal GDP (including inflation) since then.

If that happened, stocks would rise almost 60% from current levels and would match the valuation excesses at the top of the dot-com boom.

But don't worry bears, the market won't stay there. At some point, probably because inflation ticks up to a level we really notice, Bernanke will have to reverse policy or, more likely, will be dragged kicking and screaming away from the controls.

Then the bond market, free from Bernanke's artificial torrent of purchases, will crash, and yields will rise, probably to around 5%, their level in 2007 (they may need to go further before inflation is conquered, however). Without the bond market pushing it upwards, the stock market will crash.

How far will it crash? Well, on February 23, 1995, the day Fed chairman Alan Greenspan changed U.S. monetary policy and started printing the stuff, the S&P 500 index stood at 487.

Inflate that by nominal GDP since the first quarter of 1995 and you get to 1056. Take the Fed Model on cyclically-adjusted earnings and the 1962-2012 average of interest rates (6.6%) and you get to 981. A similar calculation on dividend yields, where the long-term average yield is 3.3%, gives a level of 935.

In other words, all three methods agree that the S&P 500 index will at some point fall to around 1,000.

So here's the bottom line for investors: You better make some serious $$$ on the way up in 2013, because 2014 doesn't look too good-even if you use the Fed Model.

Source :

Money Morning/The Money Map Report

©2013 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email:

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules