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1992issue C031-10

Constructing an index nominal from smoothed earnings and effective rates

A least-squares earnings path and an effective-interest-rate produce a nominal-value for the broad composite. Yield-correction and a dividend-ratio overlay then place the industrial average in the same rate regime, rather than against a headline multiple.

  • Index level is built as earnings over an effective-interest-rate, not as a standalone price-to-earnings multiple.
  • Average-earnings is a least-squares yearly path dated one year, or four quarters, ahead of the price observation.
  • Yield-correction and dividend-ratio let the industrial average share the same least-squares-baseline as the broad composite.
  • A sharp earnings drop can push a reported multiple above 100 while the rate-based nominal-value remains the comparison path.
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Current trackFundamental overlay33 readingsLinear regression112 readings

A rate-based index identity

The archive constructs the index level as proportional to earnings divided by a composite effective-interest-rate. That construction is not a standalone price-to-earnings multiple.

The fitted result is a nominal-value: the index level implied by smoothed forward earnings, the effective-interest-rate, and yield corrections.

Average-earnings one year ahead

The earnings input is a smoothed yearly path dated one year, or four quarters, ahead of the price observation rather than the latest quarterly print.

That average-earnings path is obtained by a least-squares fit in calendar time defined as year plus quarter divided by four, offset from 1900.

Building the effective-interest-rate

The effective-interest-rate combines a three-month bill yield with spreads to a long bond and to year-over-year consumer-price change. It then enters as a power of the bill yield with a slowly drifting exponent.

A separate dividend-yield multiplier of a few percent is applied so payout changes adjust the fitted composite level. That small multiplier is the yield-correction.

Transferring the baseline across indices

The industrial-average construction reuses the same smoothed composite earnings scaled by ten, then applies its own yield-correction and a piecewise correction based on the dividend-ratio versus the broad index.

The dividend-ratio is the relative payout of the industrial average versus the broad composite, used to transfer the least-squares-baseline across indices.

Five-year averages and reported multiples

Five-year moving averages of price, earnings, and dividend ratios show the industrial average's premium to the composite beginning to fade in 1958, before its earnings ratio deteriorates.

Because the industrial average does not move in proportion to its own reported earnings, a sharp earnings drop can produce a price-to-earnings reading above 100 even while the rate-based nominal series is still the comparison path.

Weekly sampling of the least-squares-baseline

The least-squares output is treated as a nominal-value that can be sampled weekly and compared with the industrial average as a rate-regime overlay.

The least-squares-baseline is that fitted identity, used as the out-of-sample comparison path for the observed index.

Weekly DJIA versus model nominal value, 1989–1991

Weekly sampling of the least-squares nominal against the industrial average over two and a half years. The model sat about 15% above the average through 1989 and early 1990, tracked it in the second half of 1990, then lagged by 10–15% in 1991 before the nominal overtook price in the last four months — a buy confirmation. Points were read off the published price panel (nominal solid, DJIA dashed), not copied from the page.
Weekly sampling of the least-squares nominal against the industrial average over two and a half years. The model sat about 15% above the average through 1989 and early 1990, tracked it in the second half of 1990, then lagged by 10–15% in 1991 before the nominal overtook price in the last four months — a buy confirmation. Points were read off the published price panel (nominal solid, DJIA dashed), not copied from the page.DJIA · weekly · 1989-01-01T00:00:00.000Z to 1991-12-31T00:00:00.000Z

Raster digitization of the 1989–1991 weekly panel; y-values are approximate to the published 200-point grid. Mean-error and variance cited in the article belong to the longer Figure 5 sample, not this weekly window.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
4 of 21 in the Fundamental overlay track
19921-5 pp.Next on Fundamental overlayReal bond yields as a deficit-share regimeInflation is often treated as the primary force behind long-term yields, yet multi-decade U.S. history includes long stretches when yields and inflation moved far apart.
All readings on this track · 21 readings
  1. 1991Growth earnings and price-to-earnings as a market-regime overlay
  2. 1991Earnings-price reliability as a first gate for growth-sleeve construction
  3. 1991Growth-adjusted earnings years as construction filters
  4. 1992Constructing an index nominal from smoothed earnings and effective rates
  5. 1992Real bond yields as a deficit-share regime
  6. 1994Relative valuation as regime context for fund allocation
  7. 1995A flattening trendline as a critique of the fundamental overlay
  8. 1998An earnings-to-price mapping is unfinished until add, reduce, and stand-aside are rules
  9. 1999Regime-aware stock exposure when rates and market condition agree
  10. 2002Short-rate velocity regimes before tightening
  11. 2003A pre-trade checklist that requires rule and fundamental agreement
  12. 2004Evaluating P/E overlays with matched crossovers
  13. 2004Constructing a stock-versus-bond regime from earnings yields
  14. 2012Cash-rich relative strength as a pre-trade portfolio filter
  15. 2012Inactivity as a feature: a small-cap earnings overlay with a monthly average and weekly MACD
  16. 2015Evaluating a capitalization-to-output-ratio as a regime overlay
  17. 2016Risk-adjusted earnings yield as a portfolio overlay
  18. 2017Oil, yields, and implied volatility as a regime critique
  19. 2017When a one-year bull sits inside a secular bear
  20. 2018A critique of rules-only trading systems
  21. 2019When seasonal and policy regimes override crowd mood
By fieldTime series and forecasting51 readingsBy year1992115 readings
All 33 readings tagged Fundamental overlay
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1991Earnings-price reliability as a first gate for growth-sleeve construction2004Evaluating P/E overlays with matched crossovers2015Evaluating a capitalization-to-output-ratio as a regime overlay1988A two-rule classroom book of cheapness and new highs1991Growth-adjusted earnings years as construction filters