U.S. stocks are at their cheapest relative to bonds since share prices began surging 2 1/2 years ago, based on a comparison between earnings and Treasury yields.
This relationship is so far out of line with historical norms that stock-market gains might be inevitable during the next 12 months, according to a study by Tobias Levkovich, Citigroup Inc.’s chief U.S. equity strategist.
The CHART OF THE DAY displays the differential between the Standard & Poor’s 500 Index’s earnings yield, the inverse of its price-earnings ratio, and the yield on 10-year Treasury notes since 1970. The differential rose above 6.5 percentage points this week, according to data compiled by Bloomberg and the Federal Reserve, and peaked at 7 points in March 2009.
“Valuations have become compelling based on 40 years of history,” Levkovich wrote yesterday in a report with a similar chart. He identified 57 weeks during the period when the yield gap favored stocks by two to three standard deviations, a statistical gauge of its distance from the average.
In every instance, the S&P 500 was higher a year later, according to the report. The average increase was 26 percent. After six months, the index was higher 93 percent of the time.
The track record is just one argument in favor of stocks, Levkovich wrote. He also cited the potential for a rebound in investor sentiment, the absence of a surge in borrowing costs, a swing toward more favorable economic data and the likelihood that share prices already account for slower profit growth.
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