Equities – The Fertile Habitat

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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