Stocks Skyrocket to Craziest Levels vs. Bonds Since Dotcom Bust!

US stocks at most expensive relative to bonds since dotcom era



US stocks have reached their highest valuation relative to government bonds in a generation, causing some investor unease over the inflated valuations of large technology firms and other major Wall Street equities. A significant surge in US equities, which achieved a new peak recently, has resulted in the forward earnings yield for the S&P 500 index dropping to 3.9%, as reported by Bloomberg. Concurrently, a sell-off in Treasury bonds has pushed the yield on 10-year bonds up to 4.65%.

This situation has led to the equity risk premiumโ€”the additional return investors expect for taking on the risk of owning stocksโ€”falling into negative territory, a phenomenon not seen since the early 2000s during the dotcom bubble. Some analysts view this as a troubling trend, suggesting investors are willing to invest in dominant technology firms without seeking a risk premium.

Market participants note that the high equity valuations, described by some as the “mother of all bubbles,” are driven by fund managers eager to capture gains from the robust economic growth and corporate profits in the US. Many believe it is essential to include the so-called Magnificent Seven technology stocks in their portfolios.

Concerns have been raised regarding the heavy concentration in the market. While some clients express anxiety about this saturation, they also question whether they should invest in these leading companies due to their anticipated dominance in the future.

The equity risk premium is often linked to the “Fed model,” referenced by former Federal Reserve Chair Alan Greenspan; however, some critics argue against using Treasury yields as a benchmark for comparison. Notably, alternative assessments of equity risk premium consider inflation-adjusted bond yields and suggest it remains low but not negative.

Additionally, analysts point out that the historical profit margins are elevated, implying that if they revert to normal, earnings growth may falter, leading to even higher stock valuations. Others propose different methodologies for evaluating the equity risk premium, incorporating future cash flow expectations.

Investors also use various measures to assess market exuberance, such as comparing US stocksโ€™ price-to-earnings ratios against historical data or valuations of international stocks. Some financial experts express caution regarding these inflated metrics and the contrast between valuations of US and non-US equities.

While many investors maintain that current high multiples can be justified based on the prevailing economic conditions, others highlight the importance of diversified equity exposure, especially amid the ongoing strength of large technology stocks.

photo credit: www.ft.com

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Source: USD @ Fri, 24 Jan.