Yield Comparison Shows Bonds Looking Cheap

Chart of the Week for January 14-20, 2000

This chart is one you’ve seen before and it bears reviewing periodically as a check on market valuations. We’ve enhanced it this time by adding the earning/price ratio, also called the earnings yield, on the NASDAQ Composite.

The earnings yield, you may recall, tells us how much earnings a stock generates as a percent of price. It can be compared to the yield on bonds to get a sense of relative return to investors.

Right now, thanks to rising bond yields, a $1,000 investment in the 30-year Treasury bond produces about $66 in cash income per year. A $1,000 investment in the S&P 500 Index today would result in about $31 in non-cash earnings to the owner/investor. A $1,000 investor in the NASDAQ Composite would “earn” just $7.50 per year—again, not in cash.

Of course, the annual income earned on a bond will not change for the life of the bond, while equity investors expect to see equity earnings grow over time. The questions are, how fast will earnings grow, over how much time, and with what degree of certainty? Bonds look enormously cheap by this valuation measure.

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