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U.S. Equities: Cheap Relative to Bonds and Inflation

Gary Black

Our regular followers are likely familiar with some of our favored equity valuation measures. Below, we show updated valuation charts comparing S&P 500 Index trailing earnings yields versus 10-year Treasurys and versus inflation. This analysis, which spans 60 years, offers a measure of the current "cheapness" of U.S. equities versus both bonds and inflation relative to the past.

Based on trailing earnings, the return advantage offered by equities versus 10-year Treasurys was about 300 basis points at the end of January; the equity advantage versus inflation was about 400 basis points. Looking back over the past 60 years, the current return advantage offered by equities over bonds would rank at the 24th percentile of cheapness (1st = least expensive, 100th = most expensive) of all observations. Versus inflation (which some investors prefer given their views that the long bond has been engineered lower by rounds of QE) equities today would rank among the cheapest 29th percentile of all observations over the past 60 years.

At yesterday's S&P 500 Index close of 1820, the current S&P earnings yield on 2014 earnings was 6.3% (2014 EPS = $115, P/E = 15.8x). Roughly, that gives equities a 330 basis point advantage versus an expected 10-year Treasury yield of 3.0% at year-end 2014, and a 460 basis point advantage versus expected 2014 inflation of 1.7%. So, equity valuations on 2014 earnings and rates look even cheaper.

U.S. Equities: Attractive Versus Bonds
Differential of S&P 500 Trailing Earnings Yields and 10-Year Treasury Bond Yields
1950 Through Late January 2014

U.S. Equities: Attractive Versus Bonds

Past performance is no guarantee of future results
Source: Standard & Poor's, Corporate Reports, Empirical Research Partners Analysis.

U.S. Equity Advantage Over Inflation
Differential of Trailing S&P 500 Earnings Yields and Inflation
1950 Through Late January 2014

U.S. Equity Advantage Over Inflation

Past performance is no guarantee of future results
Source: Standard & Poor's, Corporate Reports, Empirical Research Partners Analysis.
Trailing earnings yields less the core CPI. Prior to 1958 the overall CPI is used.

The S&P 500 Index is generally considered representative of the U.S. stock market. Unmanaged index returns assume reinvestment of any and all distributions and do not reflect fees, expenses or sales charges. Investors cannot invest directly in an index. Price/earnings represents market value divided by expected earnings.

The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.

Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable. The views and strategies described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations.

Price to earnings ratio (P/E) is a valuation ratio of a company's current share price compared to its per-share earnings. QE refers to quantitative easing, the Federal Reserve’s bond buying program designed to keep interest rates low and increase the money supply.

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