The stock market may have found an unlikely ally: a valuation model that failed investors for decades.
Ed Yardeni said on Monday that the Fed’s Stock Valuation Model may finally be working again and is sending a surprisingly bullish signal for the S&P 500. But there is one catch.
The 10-year Treasury yield cannot rise too far above 5%. That threshold could become one of the most important numbers for stocks.
Chart: 10-Year Treasury Yields Have Remained Below 5% Since June 2007
The Old Fed Model is Back
The model compares the S&P 500’s forward earnings yield with the 10-year Treasury yield.
When the earnings yield is higher than the bond yield, stocks are considered undervalued.
The forward earnings yield is the flip side of the forward price-to-earnings ratio. A forward price-to-earnings of 20 equals an earnings yield of 5%.
It is the return a buyer gets on next year’s profits, quoted the way a bond is quoted.
Yardeni named it after the model surfaced inside the Fed’s Monetary Policy Report accompanying Alan Greenspan’s congressional testimony on July 22, 1997. Fed officials never endorsed it.
It worked through the 1980s and 1990s. Then it broke, showing stocks as cheap almost all the time, and missed the financial crisis bear market entirely.
Yardeni’s argument is that quantitative easing broke the signal. With the Fed pinning the yield near zero, the comparison lost its meaning.
Why It May Be Working Again
Now Yardeni believes it may be becoming useful again.
The reason is simple: Treasury yields have moved back toward historically normal levels.
Last week, the 10-year Treasury yield stood at 4.68%. Based on that yield, Yardeni put the fair-value price of the S&P 500 at 8,300.
The index — as tracked by the SPDR S&P 500 ETF Trust (NYSE:SPY) — closed Monday at 7,785.76.
That implies roughly 6.6% upside.
The model therefore does not suggest that stocks are dramatically overvalued.
Instead, it points to something more interesting: the bond market may now matter more than the stock market’s multiple.
Then Comes the 5% Red Line
Yardeni’s model becomes much less comfortable if Treasury yields push above 5%.
At a 5% 10-year yield, the model’s fair-value P/E would be 20 — roughly where the S&P 500 trades today on forward earnings.
That means another significant rise in yields could leave stocks with little valuation cushion.
And there is a reason yields could keep climbing.
The $40 Trillion Problem
U.S. public debt has reached a record $40 trillion, including about $31 trillion in marketable Treasury securities held by the public.
Meanwhile, net interest paid by the Treasury has climbed to a record $1.1 trillion.
That creates a feedback loop: higher yields increase the government’s interest burden, while investors may demand higher yields if they become increasingly concerned about deficits and debt.
The risk Yardeni described is that “Bond Vigilantes”, a term he coined on July 27, 1983, drag the yield toward nominal economic growth, which ran at 6.5% in the second quarter of 2026.
Their message is simple: if fiscal and monetary authorities do not restrain the economy, the bond market can do it for them.
Stocks may Be Fine — Until Bonds Say Otherwise
For now, Yardeni’s base case remains constructive.
He assigns an 80% probability to his "Roaring 2020s" scenario and expects the 10-year yield to remain between 4% and 5%.
But the warning is clear.
The biggest threat to the stock market may not be an earnings collapse or recession. It may simply be Treasury yields breaking above 5%.
And if that happens, the valuation equation Wall Street is relying on could change very quickly.
Image: Shutterstock
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