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Alan Reynolds Links E-p Ratio to Bond Yield, March 21, 1991

Alan Reynolds Links E-p Ratio to Bond Yield, March 21, 1991

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Published by Alan Reynolds
The earnings/price ratio for U.S. stocks normally rises with higher bond yields and vice-versa. We cannot sensibly argue that p/e multiples are high or low without comparing them to interest rates. This became known as "The Fed Model" after July 1997, when a Federal Reserve statement mentioned it. However, my March 21, 1991 letter to institutional investors appears to be the first proof of this relationship, If so, perhaps it should be renamed the "Reynolds Model" of stock prices, rather than the Fed Model.
The earnings/price ratio for U.S. stocks normally rises with higher bond yields and vice-versa. We cannot sensibly argue that p/e multiples are high or low without comparing them to interest rates. This became known as "The Fed Model" after July 1997, when a Federal Reserve statement mentioned it. However, my March 21, 1991 letter to institutional investors appears to be the first proof of this relationship, If so, perhaps it should be renamed the "Reynolds Model" of stock prices, rather than the Fed Model.

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Published by: Alan Reynolds on Sep 14, 2013
Copyright:Attribution Non-commercial

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10/12/2014

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Alan Reynolds Associates
The
Stock
Market
Likes
Bonds
The
graph
_
presents
an
intriguing
puzzle.
Shaded
bars
show
the
ratio
of
earnings
to
stock
prices.
[This
is
the
inverse
of
the
price/earning
ratio
-a
low
bar
means
stock
prices
are
high,
relative
to
earnings.]
The
The
graph's
main
puzzle
is
that
the
stock
multiple
often
seems
to
improve
before
bond
yields
fall
-
look
at
1975, 1979-80 and
1989-90.There
is
only
one
year
on
the
graph
that
looks
out of
place
-
1987
-
sincestock
10-Year
U.S.
Treasury
Bond
Yield
and
the
Earnings/Price
Ratioof
Stocks
{S&P500
)
--
10
yr
bond
+
coreinflation
(PPI)
percent
(bond
yie
ld
&
inflation)
+
15
-
D
earnings/stock
price
e/p
ratio
(stocks)
15
I I I I I I III I II II I II I I II I I I III III I I
60
65
70
75
80
85
91
1991
is
forecast
coreinflation is
PPI
Dec-l
o
-D
ec
(less
food
and energy
after
19
73)
dark
line
shows
the yield
on
10-yearTreasury
bonds.
Stock
multiples
are
obviously
quite closelyrelatedto
bond
yields.
At
first
glance,
this
may
seem
obvious.
As
interest
rates
fall,
thepresent
value of
future
earnings
is
worth
more,
because
it
is
discounted
at
a
lower
interest rate.
prices
were
high
relative
to
earnings
(for the
year
as
a
whole),
yet
bond
yields
were
high
too.
However,
this
anomaly
was
"fixed"
in
October
of
that
year,
as
stock
prices
collapsed
and
bond
prices
rose.
Today,
high
stock
prices,
relative
to
low
earnings,
are
simply
not
consistent
with
a
bond
yield
as high
as
8%.
Something
has
to
give.
The
critical
8605 Allisonville Road, Suite105,Indianapolis, IN 46250
Affiliated with
Keane
Securities -Member
New
York Stock Exchange
SO
Broadway,New York, NY,212-422-1255; Trading, 212-422-1002 and 800-221-1920
The
information,opinions
and
recommendations herein contained represent
a
study
or
report for the
us
e
of
our
customers solely for advisory
and
mformati_ve purposes. Such mformation
has
been obtained from company reports,standard reference manuals,trade publications
or
el
sewhere.
Th
emformat1on may have been obtamed from none
orall
of
the above sources which we believe to be reliable
but
we
do not
guarantee its accuracy.

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