The Fed Model, Earnings Yields, and Bond Yields
In early 1997, in response to Federal Reserve Chairman Alan
Greenspan’s increasing concern about the impact of the rising stock
market on the economy, three researchers from the Federal Reserve pro-
duced a paper entitled “Earnings Forecasts and the Predictability of
Stock Returns: Evidence from Trading the S&P.”^26 This paper docu-
mented the remarkable correspondence between the earnings yields on
stocks and the 30-year government bond rates.
Greenspan supported the results of this paper and suggested that
the central bank regarded the stock market as “overvalued” wheneverCHAPTER 7 Stocks: Sources and Measures of Market Value 113
FIGURE 7–3
Plots of the Earnings Yields Based on a Five-Year Average of Past Earnings, January 1876 through
December 2001, versus the Next Five Years of Real Returns(^26) Joel Lander, Athanasios Orphanides, and Martha Douvogiannis, “Earnings Forecasts and the Pre-
dictability of Stock Returns: Evidence from Trading the S&P,” Federal Reserve, January 1997.
Reprinted in the Journal of Portfolio Management,vol. 23 (Summer 1997), pp. 24–35. It refers to an ear-
lier version that was presented in October 1996.