Markets Confused by Yield Parity

Earlier this year the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) yielded more than the U.S. 10yr note, check iShares Barclays 7-10 Year Trasry Bnd Fd (NYSEARCA:IEF) for example, and as of the close Friday they were yielding roughly the same at about 1.9%.

By Historic standards, that is either a remarkably generous payout for stocks, or a notably meager return for bonds. The average multiple since 1970 is essentially 2X- The 10yr note should yield twice what stocks payout in dividends. This leaves us with the $64k or perhaps more appropriately the $4.5T question. Is the S&P 500 cheap by 50% or are bonds dramatically overvalued? Recent history would suggest the former, but I would argue that both stocks and bonds are unattractively valued at current levels.

For only the fourth time in the last fifty years, the S&P 500 yields more than 10 yr Treasuries. Looking at the three previous occasions where this had occurred (June 1962, November 2008 and August 2011) ,equities rallied sharply over short-term and strongly performed over the next year-quickly closing the gap between these two markets.

I would caution Investors that the fourth time might not be a charm. P/E multiples and other equity market valuation measures look fully valued and bonds simply yield too little.

Now, this is one of those anomalies that can remain in place longer than the solvency of anyone taking the other side of the trade. It is, after all, driven by central banks with infinite capital to suppress global yields. But such fundamental aberrations are the foundations of both bond and equity volatility as investors struggle to interpret them.