For “Fed Model” fans, a SP 500 earnings yield of 5.70% with a 10-year Treasury rate of 2.19% continues to indicate that stocks are more reasonably valued than Treasuries, from a relative perspective, but the Fed Model always needs to be taken with a grain of salt.
You can never, or its very dangerous to, sum up the SP 500 in one statistical measure and then draw broad conclusions from it.
But here is what struck me running the weekly Thomson Reuters data today and updating the internal spreadsheet: with the Tech sector up roughly 20% YTD, and the SP 500 up roughly 10% YTD as of Friday, August 18. 2017, and the seeming eternity that investors have endured without a 5% correction, the SP 500 “earnings yield” is still 5.70%.
Looking back at my internal spreadsheet that has tracked the data weekly since early 2000, the SP 500 earnings yield peaked at over 9% in October, 2011, after the 20% YTD decline that year and has steadily declined since.
(For hard core SP 500 earnings yield watchers, per the SP 500 EPS data and the SP 500 peak in March, 2000, the SP 500 earnings yield in March, ’00 was 3%.)
But recent history, like the fall of 2016, just prior to the election, the SP 500 earnings yield peaked at just over 6%, from October 7, 2016 through November 4, 2016.
Prior to that it was the 8 straight weeks from January ’16 through end of Feb ’16 that saw 8 straight weeks of SP 500 earnings yield over 6%.
An SP 500 with a 6% earnings yield using recent history is telling investors that the SP 500 should be bought at that level. Doing the math further, a $138.23 forward estimate / 6% earnings yield leaves you with a 2,303 SP 500 value or a 5% drop from Friday’s closing value.
Rather than the constant cacophony of top and bottom calling in the financial media, what the data is saying is that the SP 500 continues to offer good risk / reward (in my opinion) based on this data.
If you can’t handle a 5% SP 500 correction, your investment dollars are likely better served with a CD.
Analysis / conclusion: The point of the history is that – despite the nonstop “market top” calls, the SP 500 valuation remains reasonable. Another way to think about is that the 10-year Treasury yield could double from Friday’s close of 2.19% and it would still mean the 10-year Treasury yield is still “less than parity” with the current SP 500 earnings yield. This is one of the primary reasons I’m not that afraid of a general rise in interest rates. A sharp, rapid rise in Treasury yields, yes I think that could shock stocks, but I think the SP 500 has far less downside here than Treasuries.
Jeff Miller, my Chicago bud who writes the very popular “Weighing the Week Ahead” blog in a suburb of Chicago, uses the SP 500 earnings yield as an equity risk premium proxy.
Like any data set, the SP 500 earnings yield can be tortured many different ways, but it tells me that we are in a secular bull market for stocks, and the earnings yield at 5.70% means that the SP 500 is reasonably valued.
Unfortunately I’ve been making the “Treasuries are overvalued” call for many years, and have been very wrong.
Thomson Reuters data (by the numbers as of 8/18/17):
- Forward 4-qtr estimate: $138.23
- P.E ratio: 17.5(x)
- PEG ratio: 1.78(x)
- SP 500 earnings yield: 5.70%
- Year-over-year growth of forward estimate: +9.86% vs last week’s 9.87% and still not cracking the 10% barrier.
Thanks for reading.
(Please remember, this is just an opinion, like so many others in the financial media today, along with the thousands of blogs and twitter comments, and the market opinion can change quickly. But this blog does generally reflect how we are invested for clients over longer-term time frames, and between and amongst the various SP 500 sectors written about frequently.)
Thanks for reading more…