Zeev:
John Hussman is VERY critical of the Fed model.
"Of course, one of the worst ways to detach from reality is to use a theoretically unsound model that doesn't even have historical data on its side. I'm speaking of course of the Fed Model, which now hails stocks as 40% undervalued. Well, golly gee willickers.
Recall that the Fed Model compares the prospective earnings yield on the S&P 500 (expected operating earnings / S&P 500 index) with the 10-year Treasury bond yield. I won't review the extensive theoretical flaws again, but suffice it to say that the Fed Model has quite literally zero statistical correlation with subsequent market moves. Even the handful of apparently good historical calls are better captured by rules like "buy when stock yields are high and interest rates are plunging" and "sell when stock yields are low and interest rates are soaring." Other than those few calls, zip.
The Fed Model's record is particularly distressing when it gives "buy" signals during periods of low stock yields. In general, the only reliable inference from such signals is that bond prices are about to plunge. In short, when the Fed Model gives a screaming buy signal during a period of low stock yields, sell bonds. "
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