Yields in Stocks Versus Treasuries are Abnormally High

By: John_Handbury

The “yield” from stocks is simply the amount earned by the stock divided by the price that the stock trades at.  So the “yield” on the S&P500 is the inverse of the P/E ratio, in percent.

If we compare the yield on stocks versus those on Ten-Year Notes (see chart below), we see that for the last five years, generally the yield on stocks has ran slightly higher than the Notes, by about one percent.  This makes sense since treasuries have zero risk whereas stocks do not.  The investor in stocks is rewarded somewhat for the higher risk.

However, over the last few quarters, things have not been normal.  For example, in Dec 2008, the yield on stocks was much lower than treasuries, despite the fact that the stock market was very volatile at this time.  Since then the yield on stocks has shot much higher than Ten-Year Notes, and the last data point, based on estimated earnings, is over 2 percent higher.  This could be due to investors assuming that actual earnings will be lower than projected earnings, or that the high risk in stocks demands a higher stock yield.

The writer thinks the latter is true and that investors in stocks now demand a much higher yield versus treasuries.  If earnings do not improve, this will require that stock prices fall considerably, or that bond yields drop.  Both events may happen this year.

By: John Handbury
Independent Trader

© 2009 Copyright John Handbury - All Rights Reserved
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