Citi’s latest market monitor has multiple ways to view the market, but this one stands out right now. Stock valuations are the cheapest in decades vs. bonds, based on the difference between bond yields and stocks’ earnings yields.
Our model using Baa yields instead of the 10-year Treasury shows the market is undervalued at 2.91 standard deviations below the mean. Valuations using 10-year average earnings show stocks being relatively inexpensive versus A-rated bonds. Our most highly correlated valuation metrics now shows the S&P 500 to be more than 30% undervalued.
Bonds have been beating stocks as of late, but the chart below suggests this could soon reverse, even if personally we’ve never used this method to value stocks.
(Via Citi, PULSE Monitor, Tobias Levkovich, 2 July 2010)