Tuesday, May 20, 2008

Are stocks undervalued?

Historically, the difference between the earnings/price ratio for stocks and the 10-year bond yield has been 1.75% (see figure above taken from our textbook). In our book we show how this can be used to determine whether stocks are under-valued relative to bonds.

Historical relationship: US 10 yr Note Yield - SPX EP Ratio = 1.75%
Current relationship: 3.77% - 4.23% = -0.46%

The model implies that equities are historically undervalued relative to bonds.
DISCLAIMER: If I really knew how to make money, I wouldn't tell you.

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