Are bonds or stocks overpriced? According to Cliff Asness, who Spencer Jakab of The Wall Street Journal calls a “godfather of quantitative investing,” a popular measure of comparing stock and bond prices—the so-called Fed Model—doesn’t make sense. Jakab writes:
The stocks-versus-bonds tradeoff is based on the so-called Fed Model that became popular during the 1990s bull market. The rule of thumb inverts the market’s price-to-earnings ratio to get an earnings “yield” that’s benchmarked against 10-year Treasury yields.
It’s comparing apples and oranges, though, since earnings yields can ignore inflation and bond yields can’t. The fact that they’ve often tracked one another historically doesn’t prove cause and effect. As AQR’s Cliff Asness, a godfather of quantitative investing, put it, the Fed Model has “the appearance but not the reality of common sense.”
An actual, evidence-backed way to predict long-run stock returns, says Asness? Look at the market’s P/E ratio itself. It’s well above average, and Fed rate cuts can’t do much to change that.
Take a look at the S&P 500’s P/E below:
Action Line: If you’re worried about prices, you’re worried about what someone else will pay you for assets. An alternative is focusing on generating income in your portfolio from interest and dividends. When you want to talk about interest and dividends in your portfolio, email me at ejsmith@yoursurvivalguy.com. And click here to subscribe to my free monthly Survive & Thrive letter.
