It's my opinion US stocks remain highly overvalued in relative terms versus their own debt (specifically, bonds).
This can be a very (very) lengthy post, but I plan to keep this concise, and will attempt to illustrate my view above using data from various sources. I won't spend too much writing providing explanation or definitions of these series and limit observations and opinions in order to minimalism this post.
Let's start by looking at actual value of US stocks (market capitalization) relative to the estimated value of the market capitalization using their bonds as an input. Note: In almost all periods, US stocks are undervalued relative to corporate debt. (sources: Federal Reserve)
Second, if the pinnacle of stock overvaluation relative to its debt was 1999-2000 pre-TMT bubble, we are back to that period; here is a histogram graph as well. (source: Federal Reserve). I do understand that spreads are not the same as they were in this time period, however, the return to these levels are more a function of the recent bond route in investment grade corporate bonds.
Third, the Federal Reserves actions, specifically with rate raises, has triggered a value shift from US stocks to US corporate bonds; this is nothing new. (source: Federal Reserve)
How might this manifest? Here are a few thoughts:
- Assuming investment grade corporate debt recoups 50% of its current losses from its peak, a re-calibration of historical performance between stocks and corporate bonds pins S&P 500 around 3,225.
- Assuming investment grade corporate debt is stable at these levels, ie. yields are tightly range bound and volatility subsides, a re-calibration of historical performance between stocks and corporate bonds pins S&P 500 around 2,800.
- Assuming US Stocks overshoot to the downside (similar to 2003) much like the did to the upside post-COVID and like they did in 2000, and assuming US corporate debt returns to the all-time high levels seen in late 2021, the S&P 500 would trade around 2,500.
- It would be expected that further downside in US corporate debt (investment grade bonds) would see a rapidly declining S&P 500.
The above are not market calls, but simply observations of the past.
And here are some additional charts from Bloomberg:
Recent divergence of a historically correlated series between HY CDX and Equity Risk Premiums.
Submitted October 29, 2022 at 12:58AM by NegativeTangibleBook https://ift.tt/Opord5L
