Stocks Are Cheap? Logic Says Otherwise

By BRETT ARENDS

Is it true that stocks are cheap “when compared with bonds”? That’s the line on Wall Street. If you haven’t heard it from your broker yet, you will. Indeed, in a recent report, some investment strategists from big brokerages, in their enthusiasm for stocks, argued that they were at record lows compared with bonds.

The comparison doesn’t come out of the blue. It has a long tradition in finance, where it is known as “the Fed model,” because the ratio once appeared in a Federal Reserve report.

The argument is pretty appealing to many — especially now, when bond yields are so low. The stock market today sells for about 14 times forecast earnings — or, to put it another way, if you buy $100 worth of stocks, they should generate, or yield, about $7 in after-tax earnings. That’s on par with historical averages. But that 7 percent “earnings yield” looks enormous when compared with the pitiful 2 percent you’ll earn from 10-year Treasury bonds. Wall Street will offer data going back to the 1960s that shows the two yields moving in tandem.

Read the rest here.