Valuation

Before the February/ March price decline, stock prices were at a cyclical high with the trailing PE (price/earnings ratio) in the mid-20s. However, based on the estimated earnings for the next 12 months and the S&P 500 Index at 2641 on March 30, the forward PE is around 17X. That ratio is in line with the median multiple during past business cycles.

With the government repression of interest rates from 2008 through 2016, the dividend yield on the S&P 500 has been above the yield on bonds. However, Chart B below shows that in 2017 -18 the yield on the 10 year Treasury bond began to exceed that of the S&P 500 Index. Chart C shows that by March 2018 only 116 of the 500 stocks in the Index had dividend yields above that of the 10 year Treasury yield, compared to 318 in June of 2016. Thus, bond yields are now competitive with stock yields and bonds will become increasingly attractive for conservative investors as interest rates move higher.

In mid-February of this year, the spread between the 10-year Treasury (2.87%) and the S&P 500 Index yield (1.86) reached 100 basis points (1%). (See Chart B)

20182ndqrtChartB
Chart B

Chart C shows the decline in the number of S&P 500 stocks that have yields greater than the 10-year Treasury.

20182ndqrtChartC
Chart C

While stock market swings probably will continue for a while reflecting crosswinds in the economy and the impact of headline news on investor sentiment, strong fundamentals underlying the current expansion and double digit earnings growth in 2018 should enable stocks to resume their upward trend.