Negative Risk premia

New all time high for the Dow Jones Industrial Average, the least tech heavy index of the three majors (18%). The Nasdaq 100, with almost half of its components in the the sector, is still hustling to regain its peak from 2 weeks ago. Is there any value left to support the push for new highs? It’s getting more difficult to answer yes to that question, both in absolute and relative terms: on one hand, earnings continue to come strong, although their quality has decreased significantly on the back of concentration, valuations, buybacks or aggressive amortizations. On the other, of inflation is going to pick up, and the Fed is going to start QE (formally or informally), that liquidity may end up being invested in stocks. Relative to bonds, however, the chart below indicates that bonds offer a better value alternative. The risk premium measures the difference between the earnings yield of equities (in this case the S&P500) measured as earnings per share divided by price, and the 10 year Treasury bond yield. This indicator just turned negative, signaling bonds offer a more compelling story than a equities, which is tough to swallow, in the context of potential inflation, but it’s a good measure that doesn’t provide negative readings often. It doesn’t say bonds are cheap, it’s saying that stocks are more expensive than bonds, perhaps both being overvalued. It can, and it may, reach more negative readings, but we are entering a territory where the odds are against equities from a valuation standpoint.

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