Our Stock-Bond Barometer, a model used for asset allocation, is pointing out that bonds currently provide the best value in the market. This model carefully considers various factors such as real-time data on short-term and long-term government and corporate fixed-income yields, inflation, stock prices, GDP, and corporate earnings. It distills all this information into standard deviations, or sigma, from the average.
Since 1960, the model’s average reading shows a slight preference for stocks, at 0.09 sigma, with a standard deviation of 1.05. This implies that stocks typically command a small premium, especially noticeable since inflation started rising in 2022. Right now, stocks are priced at a 0.45 sigma premium, largely due to the upward shift in long-term interest rates since the early autumn and after the recent elections.
Other valuation metrics also suggest that stocks are reasonably priced. The S&P 500’s forward price-to-earnings (P/E) ratio is around 21, which rests comfortably within a normal band of 15 to 24. Although the S&P 500 dividend yield has dipped to 1.2%, below the historical norm of 2.9%, it still represents 26% of the 10-year Treasury bond yield, a bit short of the long-term average of 39%.
Additionally, the difference between the S&P 500 earnings yield and the benchmark 10-year government bond yield stands at around 30 basis points, indicating some level of attractiveness in stock investments despite rising bond yields.
