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Thursday, July 8, 2010

Things That Make You Go Hmmm.....

In my post regarding the recent jump in earnings (go here), reader Steve Hamlin commented:

Jake - your 100 year S&P500 E/P chart would be even more interesting if you also showed *real* stock yield (against some inflation metric), or subtract out an investment grade spread. One could argue that a lot of the difference in E/P over time is due to the base interest rate at the time.
I took his advice and took the earnings yield from that post and subtracted out the yield of the ten year treasury to see the historical relative attractiveness of equities (red) and the cyclically adjusted earnings yield (i.e. 1 / Robert Shiller's CAPE) less the ten year to see a smoothed version (blue).

The results are rather staggering. For most of the period since the early 1980's, the earnings yield was actually below that of the 10 year treasury (this explains why equities have not done well on a relative basis over that time frame [see here] as all excess return had to come from growth in earnings, rather than earnings itself).

Just as interesting, is how cheap equities appear on a relative basis to treasuries at this time on a non-cyclically adjusted basis IF (the big question) they are sustainable.

Source: Irrational Exuberance