SP 500 Looks Cheap with a 1.59% Treasury Yield

(This blog post was written Friday night, August 16th but inadvertently saved as a “draft” instead of being published. It’s a few days old, but not much has changed.)

Thomson Reuters used to have a guy that managed the “This Week in Earnings” report that is punished weekly by the firm and whose data is the source of much of this blog’s earnings work over the years. Michael Thompson ( hopefully that spelling is correct) was succeeded by John Butter at Thomson after Michael left, with John now responsible for Factset’s “Earnings Inisght” every week, a Factset publication that is quite good for its depth and breadth of SP 500 earnings coverage. David Aurelio and Tajinder Dhillon are now responsible for the “This Week in Earnings” although the data is sourced from IBES by Refinitiv.

The point of all this is that years ago – in the early 2000’s – Michael Thompson was interviewed on CNBC with Mark Haines and Jim Cramer and he talked about something called the “Thomson Market Risk Premium” which is (or was) a calculation done at the Thomson earnings group that calculated what they called a “market risk” premium that was a function of the long-term earnings growth rate of the SP 500, (we’ll use 7%), an inverse of the PE ratio and then subtracts the 10-year Treasury yield.

Like the earnings geek that i am, from the early 2000’s this number has been calculated weekly on the spreadsheet, but it’s rarely discussed, since I tried to write an article on it once for a 3rd party blog and the readers confused it with the “equity risk premium” and it was such a convoluted discussion, I never tried to write about it again.

Well here goes: here is a recent history of the Thomson “market risk premium” from the spreadsheet work done weekly, after updating SP 500 earnings data from “This Week in Earnings”.

 

click to open / enhance / enlarge

 

Again, this is not an “equity risk premium” (so please be forewarned) but the Thomson “market risk premium” now shows stocks at their most attractive level since late December ’18.

Here are the last 3 week’s prints for the Thomson MRP:

  • 8/16/19: 11.41%
  • 8/9/19: 11.17%
  • 8/2/19: 11.05%

Here was the MRP at the 6/31/19 low for the SP 500 after the 5% May ’19 correction:

  • 5/31/09: 11.09%

Here was the MRP in late December ’18:

  • 1/4/19: 11.20%
  • 12/28/19: 11.06%
  • 12/21/19: 11.23%

Current SP 500 earnings data: by the numbers: 

  • Fwd 4-qtr est: $172.09 vs $172.26 from last week
  • PE ratio: 16.x
  • PEG (fwd): 9.8x
  • PEG (TTM): 3.5x
  • SP 500 earnings yield: +5.95% vs last week’s +5.90%
  • Year-over-year growth of fwd est: +1.71% vs +1.78% last week, and a very low expected growth rate

Source: IBES by Refinitiv’s “This Week in Earnings”

Summary / Conclusion:  Readers should truly take all metrics and valuation work and all opinions with substantial skepticism since – as we found out in 2008 when the SP 500 peaked at 16x earnings – valuations can look reasonable and – at least with that recession – the bottom fell out even when the Fed was sanguine, or at least less worried. Undoubtedly, the elevated MRP from Thomson is being helped by that exceptionally low 10-year Treasury yield, although “forward 4-quarter” SP 500 earnings are still growing, and haven’t fallen off the table as they did starting in August, September, 2008.

Since August 1, ’19, the corporate high yield market is down 98 basis points or just a smidge less than 1% even though the SP 500 is down about 5% from the late July ’18 all-time-high for the SP 500,so again we aren’t seeing too much “recession” concern by the credit markets (yet).

Looking back at the history, the Thomson MRP was above 11% for 40 weeks in 2016, from early January through mid to late October, 2016.

When Michael Thompson and John Butter were still around and still managing “This Week in Earnings” the weekly missive did note that with the Nasdaq in the late 1990’s and early 2000’s, the MRP did fall into the 2% – 3% range, which makes sense, since the Nasdaq 100 trading at 100x earnings during that time, implied a 0% cost-of-capital as former Chairman Greenspan noted in a few of his speeches.

The MRP is a relative risk or relative value measure with the lower readings implying stocks are expensive, and higher readings suggesting that stocks are cheaper.

Each time the MRP has gotten over 11, it usually portends positively for forward or “expected” SP 500 returns.

Out with more this weekend – thanks for reading.

 

One Response to “SP 500 Looks Cheap with a 1.59% Treasury Yield”

  1. RB

    Isn’t this just the Fed model with a fixed 7% offset? It appears that you could draw similar conclusions with a 4% threshold excluding this offset. Self-described uber-bear Albert Edwards’ 1996 thesis, based on the Japan experience, was that the Fed model was poised to break down.

    Reply

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