Fed model stock-bond comparison
IntermarketIntermediate
The so-called Fed model compares the earnings yield of the stock market with the yield on a long Treasury. A simple allocation rule owns more equities when the earnings yield is high relative to the bond yield, and more bonds when it is not. It is an intermarket valuation rule. It is not a Federal Reserve policy, despite the nickname, and it ignores inflation's effect on the comparison.
Not investment advice. Nothing here is a recommendation to buy or sell anything. Backtests and historical studies are not guarantees, and a rule that worked in one sample can fail in the next. Trading can lose money. Links are for education, not endorsements. Do your own research.
- Rules
- Compute the equity earnings yield from a stated earnings series, and subtract or divide by the 10-year Treasury yield. Tilt toward equities when the spread is above its long average and toward bonds when it is below. Rebalance monthly or quarterly. Use earnings that were reported at the time, not a later restatement. Cap the tilt so the rule cannot go all-in on one extreme print.
- Where AI fits
- AI can assemble a point-in-time earnings yield and a point-in-time bond yield, which is the part humans usually get wrong. It can test the tilt against a fixed stock-bond mix. It should not scrape a forward earnings number that was published later. The threshold belongs in a training window.
- Markets
- A broad equity index and intermediate or long government bonds.
- Timeframes
- Monthly or quarterly rebalance.
- Risks
- The comparison mixes a real-economy earnings number with a nominal bond yield. Inflation regimes make the spread hard to read. Earnings collapse in recessions just as equities become volatile. The nickname suggests official status the rule does not have. Extreme tilts are how a valuation rule blows up.