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Strategies & Market Trends : Shorting SPY for fun and profit.
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To: Berney who wrote (59)11/9/1997 1:10:00 AM
From: Premier  Read Replies (1) of 346
 
Berney,

Fed's basic assumption is that S&P's one year apreciation should equal next 12 months' earnings. This relationship should hold over a long term. In temperary periods investors may become irrational and price appreciation will deviate from this norm.

Let us assume S&P's next 12 months' earnings are $49.70, S&P is priced at $835,10 year treasury interest is 5.955%, investor has $835 to invest and her time horizon is 12 months. This investor should be indifferent to holding S&P or 10 year bond. S&P will earn $49.70 and treasury will earn 835X.05955=49.70. On the other hand, if S&P is priced at less than 835 investor should hold S&P and if S&P is priced at more than 835 today investor should hold treasury. Investor is assumed to rebalance her position after one year.

Fed model may or may not work, but its a good guide. Fed is looking at this model in setting its policy. It also gives us a deciplined approach in market timing as I suggested in another post. We may leverage our investment when market is percieved to be undervalued and lighten our portfolio when its overvalued and short the market when market is extremely overvalued.

Yardeni suggests that irrational exuberance is corrected in three ways:
1) Increase in S&P earnings 2) decrease in 10 year bond yeild and 3)downward adjustment in stock prices.

I think its an interesting concept. I do not know if it will work though.

Comments welcom.

Premier
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