ETF Trends
ETF Trends

Does the "Fed Model" created by Ed Yardeni, which uses forward earnings estimates, expose exchange traded funds (ETFs) that use these estimates to added risk? Since we haven’t seen a bear market since these funds launched, this should get interesting. Insiders are wondering if estimates lag in bear markets, does it make these models less effective?

Matthew Hougan for Index Universe reports that The Fed Model is a market timing strategy that compares the forward yield on stocks with the yield on the 10-year treasury. The model worked in the 1990s, but over the past decade this has been called a bad measure.

The major problem is that it relies on forward earnings estimates and last summer was a perfect example. Analysts were calling for a 7.7% rise in earnings for the S&P 500, but it actually fell 3.3%. By year’s end, analysts were calling for a 15.7% jump for 2008 S&P earnings, which should be coming down fast now.

Quant ETF supporters are arguing that screening methodologies can help them sidestep the worst of a pullback, and that traditional market-cap weighted funds will be exposed to the fall.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.