Bonds Finally Get the Memo

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Stocks look historically attractive based on their earnings yield (E/P) compared to the yield-to-maturity of 10-year Treasuries.

Yields are finally going up. Finally. Some may attribute the 10-year treasury yield rising to its highest level since March to the rumor that China may be scaling back its U.S. Treasury purchases. But that may be fake news. The reason yields are rising from the dead is because pro-growth business policies are unleashing economic growth. Finally. So will higher rates sink stocks? Well, higher yields are good for the Financials sector. Financial company earnings will increase when they can lend at higher rates. Financials are a significant contributor to the S&P 500 index, but are an even bigger heavyweight in Europe. In addition, the yield curve just got a little steeper. Wasn’t it the flattening yield curve that was bringing bears out of hibernation last month? Finally, bonds still have a way to go before they rival stocks in return attractiveness. Compare a 10-year treasury yield of 2.6% to the S&P index with a p/e = 18.2. To determine the earnings yield of the S&P500 calculate the reciprocal of the 18.2 p/e or 1/18.2. This equates to roughly a 6% yield. Therefore, stocks are still comparatively attractive to bond yields which are still in the early stages of reflating to normal. Stay tuned for Q4 earnings season on tap. Many of the big financials begin reporting tomorrow. Double digit growth is expected despite numerous expected one-time write offs attributable to the tax reform package. Compare stocks and bonds using the Fed Model on slide 20 of the Global Perspectives™ book.

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