Weigand, Robert A.; Irons, Robert
April 2006
Investment Management & Financial Innovations;2006, Vol. 3 Issue 2, Special section p30
Academic Journal
Compression and expansion of the average market P/E ratio significantly affected U.S. equity returns in both the bear market of 1969-1981 and the bull market of 1982-1999. We compare two models of the market P/E ratio to determine which paradigm is most useful for financial analysts and portfolio strategists trying to anticipate the future direction of the market P/E. We find that the �Fed Model��where investors benchmark the earnings yield on stocks to the 10-year T-note yield�provides a better description of how the market P/E ratio changes over time than the mean-reverting model posited by Campbell and Shiller (1998, 2001). These results suggest that high market P/E ratios and the low expected return on equities that accompany high-P/E environments could persist for an extended period.


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