Equities – The Fertile Habitat

 

Rob Zdravevski

Rob Zdravevski

Global Investment Advisor at Karri Asset Advisors

by Rob Zdravevski

July 15, 2020

Hello everyone,

Many think that the stockmarket is overpriced or even expensive !

Today, the forecast consensus Price to Earnings (P/E) ratio for the S&P 500 is 22.

The average P/E for the S&P 500 over the past 140 years has been approximately 15.

Yet I think that equities may be the only game in town.

I’d like to introduce you to the Earnings Yield.

https://www.investopedia.com/articles/investing/120513/comparing-pe-eps-and-earnings-yield.asp

The Earnings Yield is the reciprocal of the P/E Ratio

And so, the Earnings Yield of the S&P 500 Index is 4.5%.

In comparison, the yield for the 10 Year Treasury Bond or the “risk free rate” is currently 0.63%.

This means the S&P 500 is offering a return of 7 times more than the return for doing “nothing”.

Such a multiple hasn’t been seen since World War 2.

I’m trying to highlight a fertile habitat for investing.

For some recent context, in September 2011 (once the market cratered and then stabilised following the 2008-2009 Financial Crisis), the forecast P/E for the S&P 500 was 10.5 and so its Earnings Yield was 9.5%.

Comparatively, the 10 year bond was yielding 1.9%

At that historic nadir in stock prices, the market was offering a return of 5 times above the risk free rate.

Then the S&P 500 more than doubled in the next 7 years.

And more recently, in December 2018 (somewhat before a further 31% spurt in the S&P 500 Index over the next 14 months), the Earnings Yield of 6% (because the P/E was 16.8) was only twice that of the 3.1% 10 year Treasury Bond Yield.

Incidentally, that 3.1% 10 Year Bond Yield was the highest interest rate seen since June 2011.

The current “spread” which I mention in the opening paragraph coincides with my blog post about the real bull market may yet to be seen.

https://robzdravevski.com/2020/05/20/bull-markets-you-aint-seen-nothing-yet/

p.s. the forecast for the S&P 500 in 2022 is lower than 22, which mean a higher Earnings Yield.

rob@karriasset.com.au

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