Valuation
Fed model
A rough comparison of the market’s earnings yield with the government bond yield.
How it works
The idea is that shares look attractive relative to bonds when the earnings yield exceeds the bond yield, and unattractive when it does not.
It captures something real — that higher rates make future profits worth less today — while being far too crude to use on its own.
Where it misleads people
It compares a real yield to a nominal one. Earnings grow with inflation and bond coupons do not, so the comparison is not like for like and breaks down badly in high-inflation periods.
Related terms
- Earnings yieldEarnings per share divided by price — the P/E ratio inverted, expressed as a percentage.
- Risk-free rateThe return available with essentially no risk of default, used as the baseline for every other return.
- Discount rateThe rate used to convert future money into what it is worth today.
- InflationThe rate at which prices rise, which means the rate at which each pound or dollar buys less.
More in Valuation
Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.