It's important not to lose sight of the fact that assets and asset classes are all in a "beauty parade" vying for the attention of investors. It's a relative game, so in a parade of ugly ducklings, the objective is still to identify those that are more attractive than the alternatives, even if the absolute levels of attraction aren't great.
During the '80s and much of the '90s, the "Fed Model" for equity market valuation was popular, with the S&P500 earnings yield and the 10 year US Treasury yield moving roughly in sync. They separated significantly very late in the '90s as bond yields rose and equities entered their parabolic phase, causing the earnings yield to plummet even as Treasury yields rose, ending in tears for equity holders...
Since the GFC and the (ultra) low rates that followed, there's been a gulf between the 10 yr yield and the S&P500 earnings yield, and a lesser but still great gulf between 30 yr Treasury bond yields and equity earnings yields. Essentially, investors chose to
largely ignore the very low bond yields in their valuation models, avoided bidding up stocks to levels implied by the Fed Model, and prudently choosing to treat those Treasury risk-free rates as a passing temporary phenomena that would revert in time to more normal levels.
What's happened now? Treasury yields have plummeted even further:
- 30 Year Treasuries today yielding <1.2% (vs. nearly 3% one year ago)
- 10 Year Treasuries today yielding <0.6% (vs. >2.5% one year ago)
Consequently these are some of the things that equities are competing with:
- 30 Year Treasuries on a PER of 85
- 10 Year Treasuries on a PER of 169
....return of principal and payment of coupons guaranteed (desirable!), but no growth of capital or coupons, nominal returns only. Clearly, very popular at the moment.
Forecast 2020 earnings for the S&P500 have understandably plummeted, from $177.77 at the start of this year (2020 PE of 18.2) to the low $130s today (2020 PE of >22). Earnings forecasts could continue to fall, causing the fwd PE ratio to increase further. But still, even if earnings fell 50% more than currently forecast, at current equity prices the earnings multiple would still be half that of the 30 Year Treasuries PER.
And obviously equities are perpetual securities, so holders have a claim on *all* future earnings, not just the next 30 years' worth, allowing them
if they so choose to look through fallow periods so long as they are confident that one day attractive cash flows will return and potentially grow again in the future, as has happened throughout history.
Bear in mind that if today investors en masse decided to ascribe valuation multiples to equities in accordance with the Fed Model then we'd see the S&P500 not at 2900 where it is today but up around the 22,000 level.
Do I think that's likely? No of course not. But, it
is possible (not a forecast, just a possibility) that investors do begin to come to believe more than they did previously that the low interest rates that we've experienced for the past decade, and the even lower rates we now have, could/will become a feature for the foreseeable future. Central banks may encourage them to think that way, as they have done in Japan, by if necessary specifically anchoring gov bond yields at low target levels until some future, desirable, but distant economic condition is attained.
In that scenario, valuation multiples could expand (very) significantly, and it's not hard to imagine how they could potentially even one day come to exceed the all-time high multiples seen at the height of the dotcom bubble. Earnings falling, equities rising; earnings levelling, equities rising; earnings eventually recovering, equities rising more - all possible if investors vote that way by ascribing higher valuation multiples because they decide the other ducklings in the beauty contest are even uglier.
Again,
not a forecast, more an exercise in imagination to consider the cup being half full, not just dwelling on the half empty view that recency bias may draw investors into overly focusing on. Be open for much better than expected outcomes, as well as much worse than expected, so as not to be shocked if markets were to take a (superficially) surprising path.
NB Not a forecast, if I've not stressed that enough