“Fed model” is not a model used at the Fed

Here is a story on Bloomberg trying to be bearish on equity valuations because analysts are too optimistic on forward earnings.

FWIW, I am not excited about equities here, but is there ever a time where analysts have not been widely raked for being too optimistic? Is this news?

Each analyst tends to miss when his own companies go to zero. And collectively they miss recessions.  To generalize, they get operational leverage when it is working but not when it is not working.

So at the one-year horizon, historically the bias is about 7%.  How about just netting that out — as the market very probably does — and then shut up about it? Better still, don’t value on forward earnings if you don’t like em.

This complaint about analysts being too optimistic has appeared every three months along the way to the total return quadrupling. And Shiller-smoothed earnings are now ABOVE trailing.  Again, not to sound bullish, but just not to make stuff up.

Going for balance, the journalist then trots out the “Fed model” to observe that earnings yields don’t look so bad when you compare them with Treasury yields.  I think what he might be trying to say is that the poor growth outlook is a wash within a valuation framework to the extent it is reflected in low Treasury yields.

But “the Fed” is not innumerate. It would not compare an earnings yield, which is inherently real,  with a nominal Treasury yield.  That would make sense only under two conditions. First, all movements of the nominal yield reflect changes of the real yield because inflation expectations are perfectly unchanged. Second, changes of the real bond yield tell us ZERO about growth prospects. The two are perfectly uncorrelated.

Those conditions don’t hold, and “the Fed” would not be dumb enough to assume otherwise.

I think “the Fed” model showed up as a footnote in some Fed official’s speech once and then got exaggerated and perhaps even recast. I think I know who the popularizing culprit was, but I ought not say because I am not 100% sure. But high-profile guys sometimes run with the silliest of ideas.