Saturday, August 14, 2010
With yields on 10-yr Treasuries falling to 2.7%, a level which is reminiscent of the depression and deflation of the 1930s, I thought it fitting to once again compare the earnings yields on equities with the yield on 10-yr Treasuries. Rarely have equities yielded so much more than Treasuries. The current situation is very similar to what we saw in the late 1970s and early 80s, just before Treasury yields exploded to the upside and equities began a rally that would extend for many years.
Faced with the choice between equities yielding 6.8% and Treasury bonds yielding 2.7%, a rational investor would choose bonds (and I note that bond funds are receiving strong net inflows, while equity funds are experiencing net outflows) only if he thought that equity yields were only temporarily high, and corporate earnings were about to collapse (ignoring the fact that S&P 500 earnings per share have risen at a 45% annual rate in the past six months, and are now back to the levels of July 2008). Thus, the gap between stock and bond yields is a good indication of the tremendous amount of fear, uncertainty and doubt that plagues the market these days. The stock market is priced to something a lot worse than a double-dip recession.
Since I don't see a double-dip on the horizon and I continue to believe that the economy can grow 3-4% for the foreseeable future, then I conclude that equities are extraordinarily cheap.
Posted by Scott Grannis at 11:07 AM