One of the few rational arguments left that stock multiples should continue to expand is that bond yields are at such low levels that equities still look cheap by comparison. In order to further illustrate this argument, below is a chart that makes bond valuation more comparable to stock valuation by expressing the yield of a long term treasury bond as a multiple of “earnings” (bond “earnings” taken as yield or coupon).
Today’s 2.39% yield on the 10-Year treasury bond equates to a multiple of 41.8x “earnings” (100/2.39) compared to the S&P 500 trading at 18.9x trailing as reported earnings. If those two multiples were to converge, as they did from ~1960-2006, stocks could clearly see a lot more multiple expansion.
It’s a possibility, but I wouldn’t bet on it happening. In order for stocks to match bonds at a 40x multiple, it would depend on interest rates staying where they are. That would probably take an environment with slow economic growth and low inflation, but strong and stable earnings growth. One would expect that those are contradictory scenarios, but then again, it’s the scenario that financial markets appear to have been pricing in all year.
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