There Is No Alternative

On July 15, 2020, I wrote about a relative argument for higher equity prices based on the earnings yield of the S&P 500 being at its highest factor or multiple (7 times) over the government 10 year bond yield since WW2.

I’m trying to highlight that investors are being paid well to take risk and hold equities rather government bonds.

Today, the S&P 500’s forward P/E is 21.8, which puts it on an earnings yield of 4.6%. The 10 year bond yield has risen to 0.82%, so that spread is now 5.6 times.

But the equity market remains fertile (relatively) when I compare the landscape to early 2011 when the P/E was 12. The earnings yield (EY) of 8.3% was only 2.5 times more than 3.3% risk free rate.

From there, the S&P 500 rallied 40% from 1,280 to a January 2014 level of 1,800.

At that point the earnings yield of 7% was still 2.5 times more than 2.8% bond yield (P/E was 14.3) and the S&P rallied a further 55% up to 2,800 points in January 2018.

If we exclude the six FAANMG’s stocks (whom count for 25% of the index market cap), the S&P 500’s P/E ratio is 19.

Hmmm, that 5.2% earnings yield is 6.3 times more that the 0.82% bond yield.

October 26, 2020
by Rob Zdravevski

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