SP 500 Earnings Yield / Fed Model / FOMC Meeting / Year-end Rally

“Fed Model” fans are familiar with the SP 500 earnings yield, since it is the Fed Model calculation that subtracts the 10-year Treasury yield from the Earnings Yield of the SP 500 (calculated by using Thomson’s forward 4-quarter earnings estimate and dividing it by the closing value of the SP 500) to get a broadly-based market valuation measure that was once cited by Alan Greenspan in the late 1990’s as indicative of what he thought was an overvalued stock market. ( The speech where Greenspan first referenced the Fed Model was July, 1997, per Wikipedia here.)

If we look at the yield on the 10-year Treasury in July ’97 – roughly a 5% – 5.25% yield – and the year-end SP 500 earnings (actual ’97) were $43.50 and in July, 1997, the SP 500 was trading at – let’s call it 925 – the SP 500 earnings yield was roughly 4.7%, so the Fed Model, with a value of -0.50 was indicating (probably appropriately) in mid ’07, that the SP 500 was overvalued.

So what’s the point ? While ZIRP distorts the Fed Model (Think Nikkei and Japanese interest rates), the SP 500, forward progress by the SP 500 in my opinion is likely far more dependent on SP 500 earnings growth than interest rate levels over the next few years (in my opinion).

Looking back at 2013, readers saw a sharp increase in the 10-year Treasury yield, to up to 3% by year-end ’13, and the SP 500 rose 32% on the year.

For me personally, a “normal” yield curve would have a 2% fed funds rate (about flat with long-run core inflation rate) and a 4% 10-year Treasury yield, and even that implies that the short end of the yield curve would be just break-even with inflation.

The SP 500 earnings yield as of Friday, December 11th was 6.13%. The yield was above 6% for most of August and September ’15, during the 10% correction.

The last time the SP 500 earnings yield was 6.12% was November 13th or one month ago, and the SP 500 rallied from 2,022 to 2,100 to close out November ’15.

The Fed Model is a broad valuation sword, not a timing tool, but it couldn’t help be noted when the SP 500 earnings yield of 6.13%, versus November’s yield, when the SP 500 saw a nice rally.

Also per Bespoke, bullish sentiment per AAII declined to 28.5% this week, the lowest level of optimism since the September ’15 lows.

Look for the year-end rally, possibly to start after Wednesday’s FOMC announcement.

I do expect the FOMC to increase the federal funds rate 25 bp’s.


SP 500 By the Numbers

  • The forward 4-quarter estimate as of December 11th was $123.34, down from last week’s $123.49
  • The P.E ratio on the forward estimate as of Friday, was 16(x)
  • The PEG ratio is still negative, but core SP 500 earnings growth (ex-Energy) assumed at 5% – 7% means SP 500 still has a PEG over 2(x)
  • The SP 500 earnings yield is 6.13% versus last week’s 5.90%.
  • The y/y growth rate of the forward estimate was -0.71%, the 4th consecutive week of improvement for the forward estimate. Still negative, and I’d like to see it positive.

This coming week, Oracle (ORCL) and Fed-Ex (FDX) report Wednesday night after the bell, just after the FOMC decision, so the stock’s reaction and the trading of both names on Thursday could be heavily dependent on what both companies say about 2016 after the bell Wednesday. For both Fed-Ex and Oracle, this is their 2nd fiscal quarter’s of 2016 (ends May 31 for both) and both guided softer with teh August ’15’s quarter’s results.

Basically all of the SP 500 has reported their September ’15 quarters, so with these November quarter ends, we get more input and perspective on a real-time basis.

No question FDX is a real-time economic barometer, but ORCL is likely the safer of the two stocks right now.



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