PEs and bond yields are related. But please, forget the popular earning yields and bond yields relationship! They are not related and the relationship is totally useless in forecasting the stock market. Unless you can prove it to me, of course.
The enclosed chart (click on graph to enlarge) shows a different relationship between yields and PEs. The relationship is based on more than 20 years of historical data.
a. The range of S&P 500 PE rises when yields decline.
b. The range of S&P 500 PE declines when yields rise.
The chart shows that when yields are close to 5% (as they are now), the market PE has ranged between 16 and 40. In other words, history shows that the market is relatively cheap with the PE close to 18 at the current level of bond yields. Of course, you can still have sharp corrections caused by the disastrous policies of the Fed.
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George Dagnino, PhD
Editor, The Peter Dag Portfolio
Since 1977
2 comments:
"PEs and bond yields are related. But please, forget the popular earning yields and bond yields relationship!"
Are not earning yields the inverse of PEs? If that is the case both are related except one is inversely related. Am I missing something?
So all this is saying is that the range of PE ratios is wider when bond yields are low. Can we assume that bond yields are considered the low risk choice vs stocks, and therefore the wider range is to be expected when this choice is giving a low return? Conversely, when bond yields are high, stocks have more competition for investment dollars,and the PE range is less variable?
We can see that PEs are currently in the lower realm of that historical range, however what does that tell us? Using averages can be very deceiving. We are at a low PE for some reason.The real question is whether there is some economic/political/extraneous force coming along in the near future that will move the current PE to a higher level. That is the question that this graph evokes. All we know is that, historically,(and 20 years is very little to go on), the range of PEs when bond yields are at 5% is usually much higher.
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