living in a 5%-ish Treasury world

2023 opened with the 10-year Treasury note yielding around 3.5%. We touched 4.9% a couple of weeks ago and have now fallen back a bit to 4.7%, a neighborhood where it’s my guess we’ll be living for a while.

There are an unusually large number of what I’d call extraneous factors influencing world equity markets at present: the continuing purge of non-Party entrepreneurs in China, coupled with the collapse of the country’s vitally important property market; the war that is developing in the Middle East; the rise of dictatorships around the world; the parlous state of domestic politics, where polls show that former President Trump, who panicked during the pandemic, causing a large number of unnecessary deaths, and who is under indictment for numerous felonies committed during and before his presidency, would most likely reclaim that office were the election held today…

Still, I think the most important question for us as investors is how alternative liquid investments–cash and fixed income–compare in value with, and therefore influence the valuation of, equities.

The current PE of the S&P 500 is about 24x earnings per share over the past 12 months. If we assume aggregate earnings will grow by, say, 10% over the coming 12 months, the PE of the index on forward earnings is about 21.5x.

My inclination is to use the 21.5x number. My experience is that when the market is deeply worried about future prospects, it tends to trade on actual (i.e., past) earnings. Conversely, when the market is feeling bullish it will trade on forward earnings. Also, the closer we get to yearend, the stronger the market impulse to factor into prices its estimate of following year earnings.

Overnight Fed Funds money is currently yielding 5.53%. A 10-year Treasury note issued today would yield 4.67%.

The comparable figure for the S&P 500 is its earnings yield, or 1/PE. That would be 4.2% based on trailing earnings, or 4.7% based on expected earnings over the coming year.

To me, all this says to me that stocks and bonds in the US are being priced fairly closely to one another and that stocks are already assuming that 2024 will be at least a modestly up year for earnings.

More tomorrow.

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