Why Greenspan is saying stocks are cheap

by Michael Tarsala

Former Fed Chairman Alan Greenspan thinks stocks are cheap.

He spoke at a Bloomberg event yesterday, citing low price-to-earnings ratios, and that he thinks rising earnings will at some point be reflected in the markets.

It’s true, at a little more than 14 times earnings, the S&P 500 is trading about 13% below its average going back to 1954, according to Bloomberg.

But stocks are cheap on another metric that Greenspan – perhaps inadvertently – popularized:  the so-called Fed model. It compares the stock market’s earnings yield to the yield on government bonds. It can be used as an easy way to track the value of the asset classes relative to each other.

The term “Fed model”, for reference, was first coined during Greenspan’s tenure as chairman following a 1997 Fed report that issued a market warning based on the measure.

Here’s what stock yields look like relative to bond yields right now:


Source: YCharts

As you can see, the yield right now on the S&P 500 is nearly 5 points higher than a 10-year Treasury, one of its largest spreads in the past decade.

Also check out related arguments why price trends may favor stock ownership over bonds in the coming months – and why some think “Sell in May and Go Away could be a mistake.