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Do the Spreads Between the E/P Ratio and Interest Rates Contain Information on Future Equity Market Movements?Douglas Rolph |
Abstract We examine the usefulness of the spreads between the e/p ratio of the S&P 500 index and the yields on 3-month and 10-year Treasury securities as indicators of future market conditions. We find that while spreads are not particularly useful in a regression framework, the extreme values of the spreads do contain information on the market outlook. Specifically, for the period of 1967 to 1997, portfolios that only invested in the stock index when the spreads were above their historical tenth percentile levels produced higher average returns (not statistically significant) and lower variances (statistically significant) than the stock index. Douglas Rolph is a Ph.D. student at the University of Washington. Pu Shen is an economist at the Federal Reserve Bank of Kansas City. The authors thank Robert Neal, Vance Roley, Gordon Sellon, Ross Starr, and seminar participants at the Federal Reserve Bank of Kansas City for their comments. The views expressed in this paper are solely those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Kansas City or the Federal Reserve System.Rolph e-mail: rolph@u.washington.edu
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