The Fed model and shocks to the price of credit (wonkish)

“…changes in this ratio have often been inversely related to changes in the long-term Treasury yields, but this year's stock price gains were not matched by a significant net decline in interest rates. As a result, the yield on ten-year Treasury notes now exceeds the ratio of twelve-month-ahead earnings to prices by the largest amount since 1991, when earnings were depressed by the economic slowdown.”

-Ed Yardeni, Deutsche Morgan Grenfell 1997
The Fed model
In the quote above, Ed Yardeni was talking about the price-earnings ratio of the S&P 500. That's simply price divided by earnings.

In what later came to be known as the "Fed Model," the theory is that rising interest rates hurt equity valuations. The key is the inverse relationship, earnings divided by price o...


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