Half-Truths Are Half Lies By Definition

We extend that analysis by comparing those return expectations to yields on Treasury and corporate bonds.  

The intersection between the same color vertical and trend line denotes the expected return for the respective valuation method. We show Ten-year U.S. Treasury yields and BBB-rated corporate bond yields with the dotted horizontal lines.

The table below the graph summarizes our findings.

(Click on image to enlarge)

Half-Truths, Half-Truths Are Half Lies By Definition

As shown in the graph and table, bonds, even with their paltry yields, have higher expected returns versus stocks over the next ten years in three of the four studies.

Bonds Are Rich

The story does not end there. Risk is an essential factor when comparing the expected returns of different assets. Traditionally, stocks have more than twice as much risk as measured by standard deviation than bonds. As such, the expected returns per unit of risk greatly favor bonds, even bonds with near-zero yields. Bonds may be rich, but stocks are richer.

The four graphs below, courtesy of Crescat Capital, further highlight that equities valuations are well above historical norms versus bond yields.  

Half-Truths, Half-Truths Are Half Lies By Definition

We compare the S&P 500 price to sales ratio to Ten-year Treasury yields below in the same vein. Using this statistically robust measure (R2 = .7109), the S&P 500 is 20% overvalued relative to current ten-year Treasury yields. If we assume ten-year yields go to zero, it is still 10% overvalued.

Half-Truths, Half-Truths Are Half Lies By Definition

Earnings and GDP

Another popular narrative tells us that a lower discount rate applied to expected earnings improves the present value of said earnings. That is another half-truth.

Mathematically, a lower discount rate, with everything else equal, boosts the present value of expected cash flows. Unfortunately, everything is not equal.

Discount rates are based on risk-free yields, which are highly correlated to economic growth. Yields and economic growth rates have been in decline for the last 35 years. Not surprisingly, the growth rate of corporate earnings follows the same trends. The graph below compares the secular growth trends of yields, GDP, and profits. While corporate profits are much more volatile, the trends are in sync.

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