This is the absolute worst reason to be bullish on stocks right now By Mark Hulbert
* July 22, 2016
Don’t count on higher prices just because interest rates are low
Here’s my pick for the worst reason to be bullish right now: The argument that stock prices will go up because the market’s earnings yield is so much higher than the 10-year Treasury yield.
I know, I know — it’s really saying something to call this the worst. After all, Wall Street is swamped every day by hundreds of theories that cannot stand up to even minimal statistical scrutiny.
But this particular argument is perhaps the most widely repeated of any nowadays. As so often happens on Wall Street, traders even have started using an acronym to refer to it: T.I.N.A., for “There Is No Alternative.”
Fact is, this argument has no historical support. None.
The T.I.N.A. argument fails not because the current earnings yield isn’t higher than the 10-year Treasury yield. It very much is: The S&P 500’s SPX, -0.36% yield (the inverse of the P/E) currently stands at 4.1%, far higher than the 1.6% yield of the 10-year U.S. Treasury TMUBMUSD10Y, +2.20% — a spread of 2.5 percentage points in favor of equities.
Where the T.I.N.A. argument falls flat is the absence of any correlation over the last century between the magnitude of this spread and the stock market’s subsequent return. In fact, the stock market’s average return has been particularly poor following times when this spread was in the vicinity of where it is now.
The chart above summarizes what I found upon analyzing the stock market’s history back to 1871, based on data from Yale University professor Robert Shiller. Notice that the stock market historically has performed quite well, thank you, when the 10-year Treasury yield was higher than stocks’ earnings yield — not lower.
Stock market historians will notice a strong similarity between the T.I.N.A. argument and the so-called Fed Model, which gained widespread popularity in the late 1990s and the years prior to the 2007-2009 bear market. That model also failed to stand up to historical scrutiny.
As many pointed out then, the Fed Model didn’t just fail to have strong statistical support; it also lacked a sound theoretical foundation. After all, equities are supposed to provide a higher return than Treasury securities, since they are substantially riskier. Comparing their two yields is like comparing apples to oranges.
Consider the magnitude of the so-called “equity premium” — the extent to which stocks historically have outperformed Treasurys. According to data from research firm Ibbotson, this premium has been more than four percentage points on an annualized basis since 1926. So you could draw a bearish conclusion from the current spread of just 2.5 percentage points between the stock market’s earnings yield and the 10-Year Treasury yield.
I’m not necessarily advancing that bearish argument. But if you were basing a strong bullish stock market bet on the apparent lack of a good alternative, you might want to reconsider.
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