AllMarket Outlook
logoArgusSeptember 03, 2020

Daily Spotlight: Stocks Now At Premium To Bonds

Market Outlook
Bullish - Short term

Our bond/stock model asset allocation now favors bonds over stocks, despite record-low yields, as the April-August rally in equities has lifted them to near-record price levels. This is the first stock-market premium to bonds since 2007. Our model takes into account current levels and forecasts of bond yields, inflation, stock prices, GDP and corporate earnings. The model output is expressed in terms of standard deviations to the mean, or sigma. The mean reading from the model, going back to 1960, is a modest premium for stocks of 0.18 sigma. The current valuation level is 0.29 sigma premium for stocks -- a slight overvaluation. The model has generally done a good job of highlighting value. For example, stocks were very attractive compared to bonds in the late 1970s, when benchmark Treasury rates were in the high teens before heading consistently lower over recent decades. The model indicated that stocks were at a sharp premium to fair value prior to the "dot-com" crash of 2001 and also at a premium prior to the Great Recession in 2007-2009. Starting in 2009, the model favored stocks -- another good call. As the chart shows, the market can manage with premiums and discounts for extended periods of time. Equity valuations will likely start to improve once corporate earnings begin to rebound.

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