The Fed Valuation Model is Slowly Moving Away from Extreme Undervaluation
Interest rates and stock prices have been rising while forecasted earnings gains are flattening out. In the Fed Valuation Model 
, these three factors combine to make stocks appear less undervalued. At press time (April 20), the model was saying stocks are 25.2% undervalued relative to the bond market. This still represents a significant degree of undervaluation, but is not as severe as the readings in the mid-to-high 30s that prevailed throughout most of last year.
If the Fed Model is correct, we would have expected such undervalued readings to put a floor under any stock market selloffs. And that is what has happened to date. In this cycle, the model first indicated undervaluations of as much as 25% in July 2002 when the S&P 500 fell to the 850 area. Since that time, stocks have traded between 9% lower and 54% higher from that level. As Mark pointed out in Consistency = Powerful Gains for SMI's Upgrading Portfolios, it's been a long time since the market experienced a 10% correction. Perhaps the Fed model has the best explanation for that — for the past few years, stocks have offered better value to investors than their primary competition, bonds. 
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