by Michael Tarsala
Stocks are still cheap in comparison to bonds -- even looking at the relationship through several different lenses.
You've probably heard this argument before: Stocks are the superior choice right now because the yields on equities are far surpassing the yields on 10-year Treasuries.
Source: YCharts
You would think that rational investors would gravitate more toward the historically high yields offered by stocks, when bonds are giving them so very little.
There is one important counter to that logic: The Fed's stimulus actions have distorted this ratio, artificially stunting bond yields. Adjusting for that, stocks might not look so cheap. Right?
So the folks at Macrofugue attempted to do a pure apples-to-apples comparison. They looked at bond vs. stock yields by only comparing the markets where the Fed does not participate.
Source: Macrofugue.com
The "normal" S&P 500 earnings yield vs. the Treasury yield is in black. You'll notice that stocks tend to perform well when the black line is near a peak.
The "apples-to-apples" comparison that only compares bond markets where the Fed does not intervene is shown in blue. And the results are quite similar, other than stocks tend to outperform even more when the blue line rises above 1.5%, noted by the scale on the left.
Upshot: The research makes the case that stocks are indeed the rational choice. And if investors behave rationally, that makes the case for more potential stock market upside.
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