Daily Spotlight: Stock Valuation Improves

Summary

Our stock/bond asset-allocation model, which we call the Stock Bond Barometer, is indicating that bonds are the asset class offering the most value at the current market juncture. But not by much. The model takes into account current levels and forecasts of short-term and long-term government and corporate fixed-income yields, inflation, stock prices, GDP, and corporate earnings, among other factors. The output is expressed in terms of standard deviations to the mean, or sigma. The mean reading from the model, going back to 1960, is a modest premium for stocks of 0.16 sigma, with a standard deviation of 0.97. In other words, stocks normally sell for a slight premium valuation. And that’s where we are today. The current valuation level is a 0.19 sigma premium for stocks, just above the historical average but well within the normal range — and down from a 0.34 sigma premium last month. Other valuation measures also show reasonable multiples for stocks. The current forward P/E ratio for the S&P 500 is approximately 20, which is within the normal range of 13-24. The current S&P 500 dividend yield of 1.3% is below the historical average of 2.9%, but is 29% of the 10-year Treasury bond yield, compared to the long-run average of 39% and the all-time low of 18% in 1999. Further, the gap between the S&P 500 earnings yield and the benchmark 10-year government bond yield is about 320 bas