“Where you gonna go?”
- Oct 03, 2019
Where you gonna go?
That’s the question I’ve asked myself as the market has sold off in recent days.
Are you gonna go into 30-year U.S. Treasury bonds? They’re yielding 2.085%. Imagine that. You get 2% a year for lending the government money for 30 years! Not unless you have to.
Where you gonna go?
Are you gonna go into 10-year U.S. Treasury bonds? They’re yielding 1.522%. Imagine that. You may as well stay in the stock market for that too.
No ladies and gentlemen, smart investors have few real places to go right now. And that’s why I’m not sure the stock market is gonna get as hammered as some folks think.
Let me explain….
The S & P 500 is currently trading at 2882.24 and is expected to post 163 in cumulative 2019 earnings. That gives the S & P 500 a current P/E of 17.6 (2882/163). In a very real sense, stocks seem reasonably valued.
Another popular way pro’s use to tell if a market is overvalued is with the Earnings Yield (EY). This tells you what the earnings on the S & P would look like if it were presented as a bond yield.
To discover the Earnings Yield, we divide the trailing 12 months earnings of 135.64 (thru March 2019) by the price of the S & P 2887. That brings us to an Earnings Yield of 4.67% (135/2887). That means the S & P 500 is currently yielding 4.67%.
When analyzing stocks, professional investors start with the 10-year bond rate (1.522%). Then they add what’s called a risk premium to account for the risk that comes with investing in stocks instead of bonds. That equity risk premium is usually 3%.
An S & P 500 Earnings Yield of 4.67% means the index is fairly valued on an interest rate basis. Why?
Add those two numbers together and you get 4.522% (1.522% 10-year bond rate + 3% equity risk premium). That’s very close to today’s Earnings Yield of 4.67%.
Does that mean the stock market won’t go down from here? Of course not. Scared money isn’t smart money.
But it does mean that even scared investors won’t be able to run very far before stopping and asking themselves “Where we gonna go?”
“The Buck Stops Here”