Will The Market P/E Ratio Revert Back to Average?
Weigand, Robert A.
Washburn University. School of Business
Kaw Valley Bank
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.