Rising Treasury yields and the biggest equity market rally in 16 years are leading one measure of stock valuations to the most bearish level since 2011.
Profits as a percentage of the Standard & Poor’s 500 Index’s (CME:SPH14) price, known as the earnings yield, totaled 5.76% last week, compared with the 2.86% payout on 10-year Treasuries (CBOT:ZNH14), according to data compiled by Bloomberg. At 2.9 percentage points, the gap, which narrows as equities get more expensive relative to debt, is the smallest since March 2011.
The last time spreads between bond and earnings yields were this compressed, the S&P 500 posted its biggest retreat of the bull market, falling 19% between April and October 2011. The index hasn’t lost 10% since then. Wall Street strategists have forecast the weakest share advance in almost a decade for 2014, as a reduction in Federal Reserve bond purchases pushes up Treasury yields from 1.75% at the end of 2012.
“We are due for a correction,” said Peter Sorrentino, who helps manage about $14.8 billion at Huntington Asset Advisors in Cincinnati and is buying options to protect against a decline in the stock market. “It’s not a question of if, but how bad.”
Stocks fell the first three days of January, the longest stretch to start a year since 2005. The S&P 500 has lost 0.3% so far in 2014, compared with a 0.7% gain for government notes, data compiled by Bank of America Merrill Lynch and Bloomberg show. Yields on 10-year Treasuries will rise more than 0.55 percentage point by the end of the year, reaching 3.43%, according to the average of 64 economists surveyed by Bloomberg. The S&P 500 slipped 0.2% to 1,839.14 at 9:31 a.m. New York time today.
The index posted a 30% gain in 2013, beating government debt by 33 percentage points, the widest margin since at least 1978, according to data compiled by Bank of America Merrill Lynch and Bloomberg. U.S. bonds fell 3.4%, the first drop since 2009.
Analysts are the most bearish on individual companies since at least 2004 just as valuations for stocks from Alcoa Inc. to Tyson Foods Inc. have risen to an almost four-year high. Last year’s rally helped push the S&P 500 earnings yield down about 1.3 percentage points as Treasury rates climbed the same amount, narrowing the gap by the most in four years, data compiled by Bloomberg show.