Bond Yields Compared to Equity Yields

http://www.bloomberg.com/apps/news?pid=20601170&refer=home&sid=aS8Q29PCJq00

From the article.

Stocks fell to the lowest last month relative to bonds since the 1970s according to the so-called Fed model, which was cited by former Federal Reserve Chairman Alan Greenspan a decade ago. Equities yield 4.17 percentage points more in projected earnings than 10-year government bonds paid in interest at the end of 2007, according to an analysis of 29 countries by New York-based Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm by market value.

and

The gap is now the widest since September 1974, when adjusted for volatility, the data show. The last time the spread was wider, equities outperformed debt by 24 percentage points in the next 12 months, according to Lehman.

This is the biggest bullish argument I think right now. The spread between bonds and equities is what keeps me up at night. Along with inflation I have pondered that point more than any other point. I don't have a great answer. If I was a macro guy and was running a large asset allocation portfolio and could choose only between stocks and bonds I would be 100% stocks and 0% bonds. There is no question in my mind bonds will underperform stocks but will it happen through bonds going down more than equities going down or bonds go down and equities go up?


My guess is we will see something similar to the 24% point outperformance by equities. The key to this whole thing though is inflation. If I am right in my thinking that inflation picks up speed, equities won't be going up much and bonds will go down alot more shrinking the yield difference. Right now everyone sees recession, a fear in the banking market, and a corresponding flight to safety pushing down treasury yields. If people stop worrying about the banking system then all of a sudden you may see a reverse as people worry more about the eroding of the value of their money (through inflation) rather than losing all of it (through banking insolvency). Because of banking fears we may be at one of those rare points in history where equities are telling the better (or I should say more true) story rather than government bonds.

If the bond market is telling the better story than we are at the buying opportunity of a lifetime.