January Charts of Interest: Yields Are Falling

Barry from TX posted 6 months ago:

Charles, #1Thanks for posting the Jan COI from your basement in chilly Chicago. Wayne and Garth started that way and made it big. #2 The AAII Investor-Market Sentiment Model reports that yield spreads dropped from about 3.5% in Jan 2025 to about 1% in Jan 26. #3 “When markets feel disconnected from economic reality, it’s natural to reach for frameworks that claim to explain what’s happening and what might come next.” // Below, I quote the Latest Fed Model Analysis from 1/21/2026. This demonstrates the value of this AAI Premium offering and provides insights into the history of the dynamics between market earnings yields and bond yields. The Fed Model, a YIELD SPREAD valuation tool, compares stock earnings to bond yields. It’s simple. It’s intuitive. It gets a lot of airtime in financial media. The article below offers a clear-eyed explanation of the Fed Model, how it works, when it has worked, and when it falls short. Whether you’re a DIY investor or a financial educator, this is your guide to interpreting what the Fed Model can—and cannot—tell us about markets today. /1/ [I have inserted hash marks to separate paragraphs due to the limitations of this posting program. “The market sits in an extraordinarily rare configuration that has appeared just 3 times in 673 months of data—a frequency of 0.45%. The January 2026 setup combines earnings yields @ 3.13% with Treasury yields @4.20%, a specific pairing that occurred only once before in modern history (August 2002, the last year of the dot com bubble). The mechanical drivers differ profoundly. In 2002, depressed earnings yields reflected collapsed corporate profits in the post-tech-bubble recession. In 2026, low earnings yields stem from expensive valuations during economic expansion, with the S&P 500 trading at nearly 32 times trailing earnings. /2/ “This creates an unstable equilibrium—expensive equity valuations existing alongside elevated risk-free rates. When we widen the lens slightly, requiring only that earnings yields fall below 3.25% while UST yields exceed 4.00%, we find this combination has materialized in just 32 of 673 months across 5 decades. This is not typical market behavior. It represents a fundamental contradiction: investors paying 32x earnings for stocks while UST10 yield 4.20% SIGNALS competing narratives about future returns. /3/ “The Fed Model's 1.7th percentile ranking on a 10-year lookback confirms this represents a historical extreme, with strong agreement across all timeframes. Both 1-year and 5-year percentiles cluster in the low single digits, indicating this is not a fleeting aberration but a sustained state of bond preference over equities. The three-month duration in Very Low territory marks the first extended period at these levels since early 2024. /4/ “Historical resolution patterns favor Treasury yield movement over earnings yield adjustment. When August 2002's comparable configuration resolved over the subsequent six months, Treasury yields fell 36 basis points while earnings yields rose just 34 basis points—the bond market moved first. This makes intuitive sense: monetary policy and rate expectations shift faster than corporate valuations compress or earnings growth accelerates. /5/ “Forward return analysis from 145 comparable periods shows modest average outcomes—just 6.05% over 12 months—but with extraordinary dispersion ranging from -38% to +52%. The widespread reflects the volatile nature of extreme Fed Model readings. Recent 2020s data shows unusual resilience with 100% win rates and 20% average returns, though this coincides with unprecedented monetary and fiscal stimulus that may not repeat. /6/ “The Fed Model practical monitoring framework centers on one variable: UST10 yields. A sustained break below 3.85-4.00% would validate current equity valuations by making the earnings yield gap acceptable. /7/ “Conversely, a move above 4.40-4.50% would intensify fundamental tension, likely forcing equity repricing. /8/ At 4.20%, we sit in the middle of this critical range. The market cannot maintain expensive valuations alongside elevated rates indefinitely—one must give way. History suggests the Treasury yield resolves this contradiction before equity multiples adjust meaningfully.” /END/ I hope this helps you understand why Charles made the interplay of market EPS yields and UST yields the lead story in this COI. Regards.

Barry from TX posted 6 months ago:

Charles, #1 comparative data helps me understand “eye candy” statistics so I can place the data in context. #2 This enables me to compare prior (historical) probabilities and to estimate post (Bayesian) probabilities. Like the Reverend Bayes, I want to know where the most recent snooker ball (my estimate) is on the snooker table (the sample space) and how the most recent changes impact "the angle" I choose for my next shot. #3 Such data would have enabled interested AAII members (or maybe just me) to place the AAII member estimated projections solicited for the 2026 market into context. #4 With these data, members can estimate (maybe just eyeball) how good (or as lucky as a blind chimp throwing darts) we are at forecasting. #5 Charles, is there any chance of a follow-up post with these data or a reference to some? #6 Better yet, in the future, can you make comparative data for AAII member forecasts an "improvement' when you report future member data so members can have feedback on their forecasting capabilities and improve their accuracy (or not). #7 I would settle for historic SDs. I can do the math from there. Regards.