The Fed Model: Equities vs. Treasury Yields Explained

1. Origins of the Fed Model

The Fed Model is a quantitative equity valuation theory popularized by an internal Federal Reserve Humphrey-Hawkins report in 1997. It states that the stock market is in long-term equilibrium when the S&P 500 forward earnings yield equals the nominal 10-Year Treasury yield:

2. Methodological Strengths & Limitations

• Strengths: Simple, intuitive, and explains large-scale capital reallocation between fixed income and equity markets.
• Limitations & Flaws: The model commits the classic economic error of comparing a real asset (corporate equity, where earnings grow with inflation) to a nominal liability (bonds, whose fixed coupons are eroded by inflation).