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One Picture for Relative Value

There is one graph that blatantly stands out and should make you question your own asset allocation.  The graph I refer to is the ratio of the current earnings yield on the S&P 500 (Trailing 12M earnings/S&P 500 Price) divided by the current 10 year treasury yield.  This monthly graph since 1962 has looked like this:

Tonight’s closing ratio of 3.86 is significantly higher than the two previous month end peaks of 3.03 on February 27th 2009 and August 31st 2010.  If you cannot remember what happened after those peaks, here is a graphical reminder:

Maybe it is time to rethink your asset allocation with respect to equities versus bonds.

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3 Responses

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  1. Matrix says

    How do you define e peak? When do you exactly enter in the trade (buy equity)? When do you exactly exit the trade? Which is the averege return considering all history? Only two occasions are too small to draw any conclusion.

  2. SurlyTrader says

    These are monthly numbers, so I am defining the peak as the highest monthly values in those time periods. I think you are missing the point here, this is the relation between stocks and bonds and either you have to believe that earnings in the S&P 500 will drop precipitously from here to make a 2% yield on the treasury palatable. If you do not believe in that outlook, then treasury rates need to increase, stocks need to increase, or a combination of the two. Finding an indicator for the absolute bottom in any market is a fruitless effort.

Continuing the Discussion

  1. Thursday 7atSeven: long/short losers | Abnormal Returns linked to this post on August 11, 2011

    […] is a huge disconnect between earnings yields and Treasury yields.  (SurlyTrader, […]

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