Friday, December 3, 2010

Is the S&P’s Earnings Yield Saying “Buy”?

Abigail Doolittle of Peak Theories Research emails:
- The S&P’s current earnings yield of about 6.6% suggests that stocks are attractive relative to bonds with the 10-year Treasury yield at 3%.

- If we accept the Fed model’s proposition that equilibrium is found when the two match, it may imply that bonds are likely to decline as interest rates rise simultaneous to the stock market moving up.

- The latter part of this implication is confirmed by technical aspects of the S&P 500’s chart which points to an index that is likely to rise in the months ahead.
I concur with points 1 and 3, the S&P is attractive relative to bonds, especially given the Federal Reserve's current aggressive money printing posture, since it will lead to price inflation.

The price inflation will be very damaging for fixed income securities such as bonds and non-participating preferred stocks.

Many common stocks, on the other, could see earnings keep pace with inflation, and in some cases exceed inflation.

As to point 2, a model that says the yield on stocks and on bonds should be equal, simply doesn't make sense. The many more upside and downside factors with common stocks could mean that "equilibrium" at different times could mean a higher yield or a lower yield than that on bonds.

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