We have periodically provided longer-term perspectives on equity valuations focusing on P/E’s (see our previous features – Gauging Equities, PE Extremes and Equity Valuations). An alternative way to gauge equities is to compare their earning yield (i.e., E/P = 1/(P/E)) to a benchmark like Treasury yields. Coming out of the depression, equity P/E’s were in the low teens and their earnings yield well above those of Treasuries – reflecting extremely high business cycle risk. In contrast, the post- war period saw a gradual rise in P/E’s (with the exception of the 1970’s) and fall in earnings yield below Treasuries – reaching an extreme in 2000 (P/E of 50 and Eyield of 2%) at the height of the tech bubble. More recently, earnings yields have again exceeded those of Treasuries reflecting a much riskier environment.
Given their current high earnings yield relative to Treasuries equities appear to have priced in greater earnings volatility and lower growth suggesting that valuations may be attractive.
*Yoav Benari, “Optimal Asset Mix and its Link to Changing Fundamental Factors”, The Journal of Portfolio Management, Winter 1990.
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