Fact: Stocks remain attractively valued.
....
When describing the equity markets today, it's quite popular to toss words around like "bubble", "frothy", "over-extended", and "overvalued." But when we step back and take an objective look at the two most important factors, earnings and interest rates, we arrive at a different conclusion.
Everyone likes to talk about PE ratios, but not too much mention is made of interest rates. Interest rates are just as important as earnings when we assess equity market valuations. And one of the most popular benchmarks for interest rates is the current rate offered on the US 10-year Treasury Bond.
In this 15-year visual comparison of the US 10yr rate vs. the S&P 500 earnings yield, we can see that the premium between the two is currently larger today than it was during 2002 thru 2006 (which many consider to be a time of more "normal" markets). That is, given today's interest rate environment and the current earnings associated with the S&P 500, stocks are actually less expensive today when compared to the pre-recession markets.
For this exercise, I broke out the last 15 years into three subsets of 5 years each .... One period (2002 thru 2006) to represent a pre-recession benchmark. One period (2007 thru 2011) to represent the years that were most effected by the recession. And one period (2012 thru 2016) to represent the years many consider to be "frothy" for the stock market--although, as we can quickly notice, the moves in SPY are absolutely justified.
Some items to notice ...
-
The Earnings Yield Premium was positive for all 15 years
-
The average Earnings Yield Premium for 2002 thru 2006 was: 1.38%
-
The average Earnings Yield Premium during the recession-era was: 3.67%
-
The current Earnings Yield Premium in 2017 is: 3.10% (meaning, given interest rates, stocks are cheaper today when compared to the pre-recession markets)
-
Years when the Earnings Yield Premium was > 5.00% (2008, 2011, 2012) turned out to be amazing buying opportunities
-
Multiple expansion on SPY since 2008 has been counterweighted by lower interest rates. Thus, the Earnings Yield Premium hasn't changed much.
Finally, I provide three different scenarios with a range of SPY prices, SPY earnings and varying interest rates. As can be seen, SPY can continue to grow in the coming year (with earnings expected to grow by double-digits in both 2017 and 2018) without reaching levels of overvaluation. In all three scenarios, the Earnings Yield Premium does not reach the low levels (1.00 - 2.00%) we saw during the markets of '02 thru '06.
Conclusion: It will take an explosion in interest rates (unlikely given inflation expectations), a massive rise in the price of SPY, or a combination of both in order to reach levels on SPY that would truly represent areas of overvaluation. Given the two most important factors, stocks remain attractive.
Submitted June 12, 2017 at 03:48PM by canofwords http://ift.tt/2rbPkk4
