• Home
  • Finance
    • Financial Management
    • Strategic Management
    • Investment Analysis and Portfolio Management
    • Project Management
    • Islamic Banking & Finance
    • Auditing
  • Marketing
    • Principle of Marketing
    • Marketing Management
    • International Marketing
    • Advertising & Promotion
    • Commercial Challenges
  • HRM
    • Human Resource Management
    • Principles of Management
    • Training & Development
    • Employee Performance Management
  • Others
    • Introduction to Business
    • Business Communication
    • Banking & Finance
    • Entrepreneurship
    • Economics
  • Personal Skills
  • Tips & Tricks
  • About Us
    • Contact US

Business Study Notes

B.Com, M.Com. BBA & MBA Exam Study Online

  • Home
  • Finance
    • Financial Management
    • Strategic Management
    • Investment Analysis and Portfolio Management
    • Project Management
    • Islamic Banking & Finance
    • Auditing
  • Marketing
    • Principle of Marketing
    • Marketing Management
    • International Marketing
    • Advertising & Promotion
    • Commercial Challenges
  • HRM
    • Human Resource Management
    • Principles of Management
    • Training & Development
    • Employee Performance Management
  • Others
    • Introduction to Business
    • Business Communication
    • Banking & Finance
    • Entrepreneurship
    • Economics
  • Personal Skills
  • Tips & Tricks
  • About Us
    • Contact US
Home » Fed Model for Market Forecast

Fed Model for Market Forecast

By Richard Daniels Reading Time: 3 mins
Updated November 28, 2016

Fed Model for market forecast was Fed in 22nd July 1997. This model becomes popular due to its simplicity & relative accuracy over time periods. There is simple assumption of this model that on the basis of asset with higher yield, the investors easily switch between stocks & bonds which make the returns of the stock to restore an equilibrium relationship between two assets.

The Fed has used 10-years Treasuries yield to measure bond yields. Every day this number can be viewed on updated basis. The earnings yield is used to measure stock yields. Earnings yield is obtained by dividing earnings by stock price with the help of S& P 500 Index. The earnings figure is based on operating earnings and is used for as a forward 12-months earnings estimate. For example on January 1, 2016, an estimate of operating earnings for the S&P 500 Index is used for the next 12 months through the end of the year. Similarly on April 1, 2016, an estimate of operating earnings for the next 12 month s is used through April 1, 2005. The decision rules can be formulated by using Fed Model in the following ways.

  1. Stocks are relatively attractive when earnings yield on S&P 500 is higher than 10-year Treasury yield.
  2. Stocks are relatively unattractive when the earnings yield is less than 10-year Treasury yield.

There is another alternative method of using Fed Model in which Fair Value level of S&P 500 Index is estimated and it comparison is made with the actual current Index value.

  1. Stocks are undervalued if the estimated fair value of the market is greater than current level of market.
  2. Stocks are overvalued if the estimated fair value of the market is greater than the current level of the market.
  3. The Fed Model further specifies that the reciprocal of the 10-year Treasuries yield is an estimate of the equilibrium P/E ratio of S&P 500. This means
  4. Equities are relatively attractive if the actual P/E ratio of the S&P 500 is less than estimated equilibrium P/E ratio.
  5. Equities are relatively unattractive if the actual P/E ratio of S&P 500 is greater than estimated equilibrium P/E ratio.

Potential Problems with the Fed Model

Greater degree of simplicity is present in the Fed Model which provides useful signals. But still there are certain problems and limitations associated with this model. The important problems are as follow.

  1. It is described earlier in the model that linear relationship exists between reciprocal of the yield of Treasury bond and estimated equilibrium P/E ratio. This means that the forecasted equilibrium P/E ratio is 25 with the Treasury bond yield of 4 percent. However predicted P/E ratio is 50 with Treasury bond yield of 2 percent and is 100 at 1 percent. So when interest rates are unusually low then it is highly probable that the Fed Model is not reliable because it specifies that linear relationship overstate the estimated equilibrium P/E ratio.
  2. Fed Model is based on the estimated earnings of S&P 500 Index for the next twelve months. This number has different estimates including bottom-up, top down and S&P core earnings which are mostly revised. So it is hard to ascertain correctly which number to use at any particular time.
  3. The model assumed that 10-years treasury yield can be replaced for the return on equity & for the required rate of return on equities on the S& P 500 Index. This case is not true mostly in history.

In conclusion of the Fed Model, some value able insights to investors may be offered who make effort to predict the future direction of the stock market. But care is required to use this model. It is not perfect solution to forecasting problems and investors can easily be misled by using this model especially when there are unusually low interest rates.

Author at Business Study Notes
Richard DanielsAuthor at Business Study Notes

Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
Love my efforts? Don't forget to share this blog.

Related Posts:

  • Types of Bonds
    Types of Bonds
  • Bond Valuation - Basic Principles
    Bond Valuation - Basic Principles
  • Investment Alternatives for Portfolio Management
    Investment Alternatives for Portfolio Management
  • Difference between Bonds and Shares
    Difference between Bonds and Shares
  • Types of Common Stock on the Basis of Investment
    Types of Common Stock on the Basis of Investment

Filed Under: Finance, Investment Analysis and Portfolio Management Tagged With: yardeni model

Related Posts

System-Views-of-Management-image

System Views of Management

System Views System views of management associates with the Management division of the organization and it assumes that all of the organizations are … [Read More...]

Leadership Theories

Situational Leadership Theories

Situational Leadership Theories Situational model of leadership is a factor that emphasizes the behavior of the leaders regarding different situations. … [Read More...]

Behavioral Leadership Model

Behavioral Leadership Model

Leadership  Leadership is the most critical and complex responsibility across any organization. It is because the leadership requires to be realistic, … [Read More...]

career development process in hrm

Career Development Process

Career Development Process Today's career development process has become a threat for students, especially a question that may stun many students who have … [Read More...]

Strategic leadership

Strategic Leadership Model

Strategic Leadership Model The strategic leadership model is basically the study of the leadership style. It describes the ways of modernizing an … [Read More...]

Types of Managerial Decision Making

Types of Managerial Decision Making

Managerial Decision Making Decision Making is an art of selection of one feasible alternative decision from many. Therefore types of managerial decision … [Read More...]

Quantitative-management-approach

Quantitative Management Approach

Quantitative Management Approach The quantitative management approach is used to enhance decision making power by using quantitative tools. As well as … [Read More...]

Effective-business-messages-image

Effective Business Messages

Effective Business Messages The process through which business messages are effectively prepared that have the potential to create desired results from … [Read More...]

Search the Site

ADVERTISEMENT

Business Study Notes

Business Study Notes is all about business studies or business education. Visit us to find here free business notes of all the subjects of B.com, M.com, BBA & MBA online.

Disclaimer

All the images and videos present on the Business Study Notes are not owned by us, if you found anything under copyrights, please Contact Us, we will remove it ASAP.

Categories

© Copyright 2023 Business Study Notes. All rights reserved. Privacy Policy, Sitemap.  
DMCA
PROTECTED