Powell abandons Fed model to defend high stock valuations – World News

In order to defend rising stock markets against claims of overinflation, economists often cite a valuation technique that adjusts stock prices to match interest rates. The latest is Jerome Powell.

In his news conference on Wednesday, the Federal Reserve Chairman stated that stocks are unlikely to be as overpriced as they appear at first glance, relative to risk-free returns, an indicator of government bond yields. It makes sense that Powell cites the comparison – it’s a version of what has come to be known as the Fed model over the years.

“If you look at the P / E’s, they’re historically high, but in a world where the risk-free rate will be low for an extended period of time, the stock premium that is really the reward for taking stock risk would be what you’d see, ”Powell said.

The S&P 500’s return on income – earnings to share price – is 2.5 percentage points above the return on 10-year Treasury bills. The comparison known as the Fed model is well above the spread before the internet bubble burst, when bonds outperformed stocks with this move.

“The PE Mafia hates his answer, but it is what it is,” said Dennis DeBusschere, director of portfolio strategy at Evercore ISI, in a message to clients. “But waging this fight is like trying to convince an extreme partisan to change her position.”

A look at the equity risk premium offers a very different picture than a simple look at the price-performance ratio of the S&P 500. Currently, the equity benchmark is trading at 29 times the trailing profit. In 1999 that metric exceeded 30.

“Granted, the P / Es are high, but that may not be as relevant in a world where we believe the 10-year Treasury Department will be lower than it has been in the past from a rate of return perspective,” Powell said.