Earnings Yield (Fed Model)

Benchmark stock market valuations against the US Treasury market.

Market Benchmarks

Market or Stock P/E Ratio

US 10-Year Treasury Yield (%)

The "Risk-Free" Rate benchmark

The "Fed Model" suggests that stocks and bonds compete for the same capital. Higher bond yields make stocks less attractive unless earnings yields also rise.

Relative Valuation

5.00% Yield

Stocks Undervalued vs Bonds

Earnings Yield (E/P)

5.00%

Bond Spread

+0.50%

Valuation Spectrum

Stocks ExpensiveEquilibriumStocks Cheap

Bond Market Influence

When the 10Y Treasury yield rises, the "discount rate" for stocks increases, making them fundamentally worth less. High rates are the enemy of high P/E stocks.

Stocks vs. Bonds

Investors are constantly choosing where to park their capital. The two primary options are "Risk-Free" government bonds and "Risky" equities. The **Fed Model** is a theory that compares the expected return of these two asset classes.

Earnings Yield (E/P)

While the P/E ratio is the price you pay for earnings, the Earnings Yield is the earnings you get for the price (the inverse of P/E). A P/E of 20 equals an Earnings Yield of 5%.

The 10-Year Treasury

The yield on the US 10-Year Treasury is considered the "Risk-Free" rate. If bonds pay 5% and stocks yield only 4%, investors have little incentive to take the risk of owning stocks.

The Equity Risk Premium

Historically, stocks have an "Equity Risk Premium" (ERP) of about 2-3% over bonds. This extra yield compensates investors for the volatility of the stock market. When the gap between stock yields and bond yields narrows, stocks are often entering a danger zone of overvaluation.

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