Are Stocks Cheap Compared to Bonds?
The idea is ludicrous but the question came up again today in response to Charts of the Week: Valuation Inflation.
Consider this reader comment thread.
Scoot: Just to be devil’s advocate, the PE on the 30 year Treasury is over 80. It’s 170 for the 10 year.
Mish: Bonds have yields, not earnings. That aside, your comment is not DA at all.
Rather it is one of the silly justifications you hear all the time “stocks are cheap compared to bonds”. Hussman accurately blasted the concept recently.
Scoot: Do you have a link to what Hussman wrote? I could only find something from 2015 although I’ve no doubt it’s very similar. It might be a good topic for one of your articles.
Fundamentally Unsound
Please consider Fundamentally Unsound, John Hussman’s July 2020 analysis.
If someone tells you, “well, stock valuations are high, but high valuations are justified by low interest rates,” they’re actually arguing that passive investors face the worst of all possible worlds. They’re saying “well, future stock returns are likely to be dismal, but dismal returns on stocks are justified because you’re going to get dismal returns on bonds too.”
Saying that extreme stock market valuations are “justified” by low interest rates is like saying that poking yourself in the eye is “justified” by smashing your thumb with a hammer.
Worse, by our estimates, the likely 10-year total return of the S&P 500 from current valuations is about -1.4% annually.
Over the completion of the current market cycle, I expect that the entire S&P 500 total return since 2000 will be wiped out. Specifically, I continue to expect the S&P 500 to lose about two-thirds of its value. Even a 50% market retreat would bring valuations only to levels matching the 2002 low, which was the highest valuation level ever observed at the completion of a market cycle.
Here’s the crucial point. A security is just a claim on some set of expected future cash flows. The higher the price you pay, the lower the long-term return you can expect.
Illegal Fed Actions
Hussman also discusses the illegal actions taken by the Fed in response to Covid.
His article merits a read for many reasons.
For further discussion of valuations, please also see Charts of the Week: Valuation Inflation
Mish
I stopped measuring my returns against the S&P or nazzy in 2001. I measure my returns against my own performance from yesterday, last month and last year. Adapt to the conditions. Modern day volatility has allowed for outsized returns. Take advantage of this gift.
Currently, the Fed ‘guarantees’ low yield, and theoretically reduces/eliminates risk–blowing an ever bigger bubble. At such low yields, the present value impact of a slight change in yield (interest rate etc) is significant. Do the math. Go from a discount rate of 9% to 8% on a cash flow stream, then, from 0.5% to 0.4%.
Hidden in a low-yield environment is a ticking time bomb. A rate bump will savage prices.
Crashing prices will induce a risk premium, increasing yields… Now, we have a cobweb loop. Hard to control. Implosion is possible. With central banks already stretched, I don’t fancy the chances.
If the world is indeed getting into deep deflation, the US treasury yield will also become negative, like german and Japanese longterm bonds, which would be equivalent to a P/E of infinity (positive or negative). This would in turn mean that stock markets would go much much Higher!
Inflation IS depression.
my advice — do not fight the fed. this is going to be the best bull run until the next crisis. i think nasdaq tops out at 30k by the end of 2021, drops to 27k during the next crises. then heads to 100k, drops to 90k, etc. even if there is inflation, they will let it happen. inflation in the usa is different from inflation in zimbabwe or weimar germany because usd is a reserve currency. fwiw, i don’t think there will be inflation as long as all the goods that are part of the cpi come from china.
Thanks for the post & link Mish. I don’t think many decisions to buy anything recently have been based on their yields or long term returns, it’s mostly been either risk off or following the crowd for short term price gains. Balanced & diversified portfolios that are managed in return for fees are & will become more challenging as fees begin to take a greater percentage of these returns.
Since 09 stocks and bonds might be (is) the biggest scam in history,the Fed has become the Roselli Brothers of WS,enriching the likes of there masters Buffet and Bezos (B&B)to the tune of trillions while the economy rots to where virtually everything is bankrupt,headed for bankrupcy,dependent on big govt for a check,and this after “longest expansion in US history”LMMFAO!
I actually disagree with what returns will be. Once covid is on the run the market will continue its shenanigans. Market prices have little to do with reality and more to do with computers at the Fed intervening in bond markets which affects how money moves in stocks as well. Also there is more trading then investing going on. These trade algorithms can sell on a moment’s notice and buy too. This is why you never see big down days anymore. The Fed can also halt trading and intervene if there is a big down day.
You can definitely expect dismal returns if you invest with John Hussman. 10 year average annual return of his “Strategic Growth fund” is -6.8%, versus an s&p500 fund of around +18%.
Hussman continues to miss the most important things.
Yes, real returns will be crummy. But I’ll take my chances with stocks, real estate, and gold over cash and bonds.
“Hussman also discusses the illegal actions taken by the Fed in response to Covid.”
…
Skirting the law? Sure. Illegal? No.
Federal Reserve not acting as lone wolf. If it did, it would indeed be illegal.
Federal Reserve and US Treasury set up a Special Purpose Vehicle (SPV) to circumvent Federal Reserve’s limitation on what it can purchase. The CARES Act provided $75 billion to Treasury for the SPV. The $75 billion in first loss position while Federal Reserve is the lender (leverage up to 10x the $75 billion).
IF losses were to occur, it would be US Treasury taking the loss and not Federal Reserve.
I think Monday could be the starting of a fireworks. Robinhood traders might be in for a lot of pain.
So … Dow 7.5×10^20?
“I think Monday could be the starting of a fireworks.”
…
Or not.
Monday will be the announcement of the next trillion they are going to spend. A trillion here, a trillion there. Pretty soon you are talking about real money. Dow 100 quadrillion?
More like Monopoly Money -:)
Not to mention if you drive yields any lower/negative let’s see if stocks outperform gold & silver. Whatever remains of stock Vs bonds I would argue is a zero sum game that has already ran the entire field (I.e. since circa 1980ish when yields maxed and this credit cycle started. (When I started at a bond shop in 1984 someone told me when the rate on the TAX-Free zero-coupon bond I was showing him “came back to 11.35% from my offering of 11.15% “to let him know”. Hope he hasn’t waited by the phone for ~ 40 years! NOTHING IS STRONGER THAN A MACRO CYCLE.
There’s next to nothing to refi and releverage lower from this cycle. Ergo, it’s a 1930’s replay when balance sheets had destruction and a complete reset. It’s a fait accompli now.