Daily Spotlight: Stock Overvaluation Extended

Our bond/stock asset-allocation model is rendering stocks overvalued against bonds, as interest rates have headed higher. 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 0.18 sigma premium for stocks, with a standard deviation of 1.0. The current valuation level is 0.6 sigma premium for stocks, still within one standard deviation of normal. Generally, the model has 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 our chart shows, the market can manage with premiums and discounts for an extended period of time. Equity valuations will likely start to improve once corporate earnings begin to rebound.

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