Fed Model

A relative valuation tool that compares the earnings yield of the S&P 500 index to the yield on the 10-year U.S. Treasury bond, suggesting whether stocks look more attractive than bonds. A higher earnings yield than bond yield implies that equities are undervalued, while the opposite suggests overvaluation. Though popular for its simplicity and its ability to highlight shifts in investor preference between risk and safety, the model has limits: It ignores the equity risk premium, inflation and policy-driven distortions in interest rates. Best used as a sentiment gauge rather than a precise forecasting tool, the Fed Model is more of a market weather vane than a compass.