While no one can ever predict the future, valuations do matter and are in our opinion, very important in determining future results. The graph below shows that bonds are overpriced compared to stocks. The historical comparison of the Standard & Poor’s (S&P) 500 price-to-earnings (P/E) ratio to the 10-year Treasury bond P/E ratio for the last fifty-seven years is shown below. The Treasury bond P/E is the multiplicative inverse of its interest rate. For example, a 10 P/E is equivalent to a 10 percent interest rate calculated as follows:
1 /10% or 1 divided by 10% or 1/.1 = 10
Investors can use these ratios to measure whether an investment is over or undervalued. If you look at the chart, you’ll see the divergence of the S&P 500 P/E and the 10-year Treasury bond P/E from 2008 through 2019. Although stocks as a whole have remained around an average of 20, bonds have had dramatic swings up and down through the fourth quarter of 2019.
There has been much discussion in the financial press about the idea of stocks being expensive compared to long-term averages. Although it is true that stock P/E ratios (as represented by the S&P 500) are in fact moderately above historical averages—currently around 20 for the S&P 500, compared to an average of 16.7 since 1962 (source: Bloomberg)—this moderately elevated level pales in comparison to that of bonds. The 10-year bond P/E is near its all-time high of 70 (see chart above). In my opinion, bonds are grossly overpriced and potentially in bubble territory, which leads to a question you may be asking yourself: “If stocks are somewhat expensive, and bonds are extremely overpriced, where should I be investing my money?”
While you should consult with your financial advisor on the appropriate asset allocation for you given your goals, finances and age, I can provide you some additional information on diversification and other asset classes that you may want to consider. For more information on diversification, you can download a couple of free chapters of my book, Wiser Investing: Diversify Your Portfolio Beyond Stocks and Bonds.
The information is for informational purposes only. The opinions expressed or implied are exclusively those of the writer and are not to be attributed to, or presumed to be endorsed by, the author’s employer or any company with which the author is affiliated and are subject to change without notice.
The information has been derived from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Investing in stocks, bonds, and other assets which present various forms of risk to investors could result in losses and positive returns are not guaranteed. Past performance is no guarantee of future results. Diversification only reduces the risk of capital loss but does not eliminate this risk. Measures of expected return and/or expected risk are not forecasts of returns or risks but are only statistical definitions for modeling purposes based upon financial and statistical analyses. Past performance is no indication of future results, and all investments or assets could lose value in the future due to a variety of financial factors. Due to volatility exhibited in various markets, including but not limited to stocks, bonds and other forms of investable assets these markets may not perform in a similar manner in the future. Among risks which can affect value, financial assets are also exposed to potential inflation and liquidity risks. Expected returns, expected risk, and long-term targeted returns are not forecasted returns or risks but are only statistical definitions for modeling purposes. Investors may experience different results in any chosen investment strategy or portfolio depending on the time and placement of capital into any assets associated thereto. Diversified strategies are constructed to diversify from an all-bond portfolio, directed toward investment among assets that may largely, though not necessarily completely, be non-bond alternatives. Investors are cautioned that they should carefully consider fully diversifying their total personal investment allocations to incorporate a variety of investment assets which also may include stocks, stock mutual funds and ETFs, international assets, bonds and fixed income instruments (where appropriate), and other non-stock/bond investments (e.g., without limitation, Real Estate and other assets). Nothing should be considered a recommendation nor a solicitation to buy or an offer to sell shares of any security or service in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction.