Likewise, history shows there to be no predictive power for stocks when comparing equity yields with bond yields. Why should there be? Dividends are risky and rise with inflation; coupons are risk free and do not. It is like buying apples because pears are cheap. There are good reasons why equities are due a bounce – flaky valuation metrics are not among them.This is basically a take down of the so-called Fed Model (not endorsed by the Fed) that argues that comparing bond yields to earnings yields reveals information about the level of the stock market. I posted on this a few days ago here. With bond yields low and earnings yields high, numerous "experts" are claiming this is a signal that the market is undervalued. They are wrong. It is a signal that bond yields are low and earnings yields are high. That is all.
Thursday, August 25, 2011
Why P/E ratios are a poor predictor of market performance.
The Lex Column in the Financial Times today talks about why raw aggregate P/E ratios are poor predictors of stock performance. Good stuff. But the final part of the article caught my eye.