Will The Market P/E Ratio Revert Back To Average?
Weigand, Robert A.; Irons, Robert
PublisherWashburn University, School of Business
MetadataShow full item record
We show that the way investors use the "Fed Model" to benchmark the earnings yield on stocks to the 10-year T-note yield has resulted in these two series becoming cointegrated over time. The market earnings yield and its reciprocal, the market P/E ratio, become nonstationary and develop a cointegrating relationship with the yield on the 10-year T-note as the correlation between these two series abruptly increases (ca. 1960). A nonstationary market P/E ratio will no longer display mean-reverting behavior, implying that high P/E ratios and the low expected return on equities that accompany high-P/E environments could persist for an extended period.