Friday, August 12, 2011

Is The Earnings-Yield Divergence Unprecedented?

I'm a big fan of Felix Salmon (you will notice he is on my blogroll), but he dropped the ball in this post outlining the "unprecedented" divergence between the earnings yield of the S&P 500 and the ten year Treasury.:
After I wrote my post on Monday about the huge divergence in yields between stocks and bonds, I wondered just how historically unprecedented this divergence was. And now, with the help of this fabulous chart (many thanks to Nick Rizzo, Dan Burns, and Stephen Culp), it’s pretty easy to see: we’re at levels which match those at the height of the financial crisis, and which are otherwise historically utterly unprecedented.
Indeed, from 1985 through about 2002, it was just as common for the S&P earnings yield to be lower than the Treasury yield as it was for the yields to be the other way around. The two tracked each other, and the spread between them almost never moved beyond 2 percentage points either way.
Unprecedented? No...

As I outlined in a post a bit more than a year ago, the relationship between earnings yield and Treasuries is a new phenomenon (on a relative basis). If you looked past 1985 (i.e. the time in Felix' research), you would see a strong relationship going back just another 15 years or so. Before that... nothing for another 100 years.

I have no issue with an investor using this indicator to prove there is value in equities. BUT, they must believe something drastically changed around 1970 and that change remains. Otherwise, "history" indicates the strong relationship over the last 40 years may be what was unprecedented.