about 2 years ago • 1 min
Sometimes it pays to stand back from the daily swings of the markets and look at the long term. And as 2022 gets underway, one key valuation metrics suggests stocks should perform better than bonds over the coming decade.
The chart above shows how the returns on stocks relative to bonds (in green) have tended to increase with the cyclically adjusted price-to-earnings (CAPE) ratio relative to the yield available on bonds (in blue).
CAPE is a measure developed by Yale professor Robert Shiller that puts a valuation on the stock market by dividing prices by the profits generated over the previous 10 years, in order to flatten out the peaks and troughs of the economic cycle. The blue line in the chart takes this concept a step further by inverting the CAPE ratio to create a CAPE earnings yield and then subtracting the yield available from investing in US government bonds – a metric Shiller calls the excess CAPE yield.
Historically, the higher this excess CAPE yield, the greater the returns of stocks relative to bonds have been over the following decade.
The current level of the excess CAPE yield, at about 3%, is hardly shooting out the lights. But it does suggest that stocks should at least return more than bonds over the coming 10 years.
Bear in mind, however, that this doesn’t guarantee that stocks will go up in absolute terms. Both stocks and bonds could fall, but bonds could fall faster.
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