The Big Picture

Further support for my theory that the Fed is able to influence (manipulate?) the stock market by raising or lowering yields on long-term bonds. A plot of the S&P 500 price-earnings ratio against 10-year treasury yields shows a clear correlation between low bond yields and high PE ratios. Many thanks to Herb, a reader, for providing the link. One of the biggest failures of the discounted cash flow model, used by many investment institutions to value future cash flows, is the use of long-term risk-free (treasury) yields instead of a stable bench-mark rate. When yields are low, valuations rise, and when yields rise, values decline. Institutional investors often fail to increase their risk premium when bond yields are low. Ten-year treasury yields are rising, having respected the 3-year trendline. Expect another test of resistance at 5.25%. The latest rise is in part a response by OPEC oil producers to the fall in the price of crude, prompting them to liquidate some of the $97 billion in treasury bonds accumulated over the last 17 months.