S&P 500 Rally to Continue or Treasury Yields to Rise?

March 28, 2013

In this week’s chart we look at the historical gap between the earnings yield of the S&P 500 and the ten year Treasury yield. The earnings yield of the S&P 500 is the inverse of the P/E ratio and shows the percentage return in earnings for each dollar invested. We can compare this to the 10 year Treasury yield as one method to measure the difference in valuations between bonds and equities. The larger the gap is between the earnings yield and 10 year Treasury rate, the more attractive equities appear relative to bonds.

As shown in the chart, the difference between earnings yield and interest rates has been hovering near 5% for the past year. The previous time this surpassed 5% was in February 2009 which was followed by the S&P 500 bottoming that March and the beginning of a bull market. Currently, the gap is again elevated as the earnings yield has remained relatively high while ten year Treasury rates are near record lows. Could this signal that the current bull market still has plenty of room to run or that Treasury yields must soon begin to rise? This is a dynamic that bears watching over the rest of 2013.