Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
The Best “Pick-and-Shovel” Play for the Online Grocery Boom - 18th July 19
Is the Stock Market Rally Floating on Thin Air? - 18th July 19
Biotech Stocks With Near Term Catalysts - 18th July 19
SPX Consolidating, GBP and CAD Could be in Focus - 18th July 19
UK House Building and Population Growth Analysis - 17th July 19
Financial Crisis Stocks Bear Market Is Scary Close - 17th July 19
Want to See What's Next for the US Economy? Try This. - 17th July 19
What to do if You Blow the Trading Account - 17th July 19
Bitcoin Is Far Too Risky for Most Investors - 17th July 19
Core Inflation Rises but Fed Is Going to Cut Rates. Will Gold Gain? - 17th July 19
Boost your Trading Results - FREE eBook - 17th July 19
This Needs To Happen Before Silver Really Takes Off - 17th July 19
NASDAQ Should Reach 8031 Before Topping - 17th July 19
US Housing Market Real Terms BUY / SELL Indicator - 16th July 19
Could Trump Really Win the 2020 US Presidential Election? - 16th July 19
Gold Stocks Forming Bullish Consolidation - 16th July 19
Will Fed Easing Turn Out Like 1995 or 2007? - 16th July 19
Red Rock Entertainment Investments: Around the world in a day with Supreme Jets - 16th July 19
Silver Has Already Gone from Weak to Strong Hands - 15th July 19
Top Equity Mutual Funds That Offer Best Returns - 15th July 19
Gold’s Breakout And The US Dollar - 15th July 19
Financial Markets, Iran, U.S. Global Hegemony - 15th July 19
U.S Bond Yields Point to a 40% Rise in SPX - 15th July 19
Corporate Earnings may Surprise the Stock Market – Watch Out! - 15th July 19
Stock Market Interest Rate Cut Prevails - 15th July 19
Dow Stock Market Trend Forecast Current State July 2019 Video - 15th July 19
Why Summer is the Best Time to be in the Entertainment Industry - 15th July 19
Mid-August Is A Critical Turning Point For US Stocks - 14th July 19
Fed’s Recessionary Indicators and Gold - 14th July 19
The Problem with Keynesian Economics - 14th July 19
Stocks Market Investors Worried About the Fed? Don't Be -- Here's Why - 13th July 19
Could Gold Launch Into A Parabolic Upside Rally? - 13th July 19
Stock Market SPX and Dow in BREAKOUT but this is the worrying part - 13th July 19
Key Stage 2 SATS Tests Results Grades and Scores GDS, EXS, WTS Explained - 13th July 19
INTEL Stock Investing in Qubits and AI Neural Network Processors - Video - 12th July 19
Gold Price Selloff Risk High - 12th July 19
State of the US Economy as Laffer Gets Laughable - 12th July 19
Dow Stock Market Trend Forecast Current State - 12th July 19
Stock Market Major Index Top In 3 to 5 Weeks? - 11th July 19
Platinum Price vs Gold Price - 11th July 19
What This Centi-Billionaire Fashion Magnate Can Teach You About Investing - 11th July 19
Stock Market Fundamentals are Weakening: 3000 on SPX Means Nothing - 11th July 19
This Tobacco Stock Is a Big Winner from E-Cigarette Bans - 11th July 19
Investing in Life Extending Pharma Stocks - 11th July 19
How to Pay for It All: An Option the Presidential Candidates Missed - 11th July 19
Mining Stocks Flash Powerful Signal for Gold and Silver Markets - 11th July 19
5 Surefire Ways to Get More Viewers for Your Video Series - 11th July 19

Market Oracle FREE Newsletter

Top AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

Stock Market Indicator Says Stocks Should Double

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

By: Money_Morning

Stock-Markets

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 :http://moneymorning.com/2013/04/01/this-little-known-indicator-says-stocks-should-double/

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: customerservice@moneymorning.com

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 http://www.MarketOracle.co.uk - 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