“Are Stocks Cheap Or Expensive” – Here Are 20 Answers

“Is the S&P 500 cheap or expensive” – that is the question every trader has to answer every day.
It is also the question BofA’s Savita Subramanian addresses today in a report which deconstructs the “Fed model”, or the goalseeked analysis which justifies high stock multiples (and prices) as long as bond yields are low (contrary to virtually all other valuation models). This is what she says:
As equity markets make new highs, the bulls are grasping for new (or very old) ways to justify the rally. The latest to garner attention is the Fed model, which compares the earnings yield on stocks with bond yields. There have been many iterations of the Fed model over the years, but they all come to the same conclusion today: stocks are cheap relative to bonds. The bulls argue that the spread between bond yields and the earnings yield will normalize as equity valuations re-rate higher. But this is just one of the ways that the relationship can mean-revert – which it has failed to do over the last decade. The other two may not be as bullish – the spread can mean-revert if earnings were to collapse, or if interest rates were to spike. Thus, the Fed model may not be as clear cut a buy signal for equities. And critically, our analysis suggests that the various forms of the Fed model have far less predictive power than simply using a PE ratio.

This post was published at Zero Hedge on Jul 21, 2016.