The ongoing, in fact never-ceasing debate on whether stocks are cheap… and if so are they cheap enough to sustain the 4 year bull market further into 2007, is an important one.
One way to view equities is on an earnings yield ratio & the spread between bond yields and stock earnings yields (the inverse of the price/earnings ratio). The S&P 500 is forecast to have operating earnings of $90 this year, which equates to 6.4% of the index’s price of 1414. Compare that with a ten-year bond yield of 4.6%. In 2000 stocks had an earnings yield of 3.5%, while the bond yielded 6.5%.
This gap is the key driver of stock buybacks and debt-financed takeovers, as we have discussed in recent articles, which remains a key driver for the current bull market in equities around the globe. The expected 2007 earnings yield on the MSCI World Index is 7.6%, a 3.6% spread over the ten-year, GDP-weighted global long-term government bond rate. That is some gap.
