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Equity markets are not overbought, rather from a long term perspective they remain in an extreme oversold condition. In fact, they are more or less as oversold as they have ever been in the last 50 years!

When investors refer to the terms "overbought" or "oversold" they usually are referring to the price action of the major market indices. This is a very narrow definition of these terms and it is highly flawed. There is a lot more to the terms "overbought/oversold" than just the price performance of stocks. In essence a market will only become overbought if there is too much optimism and this generally coincides with investors paying too much for stocks or at least putting too much value on the sustainability of cashflows. But the cashflows/earnings of companies do not exist in isolation. There are alternative investments - namely bond markets. The attractiveness of equities must always be seen relative to bonds.

So from a long term perspective equity markets will only be overbought if valuations placed on earnings of equities are at extreme highs relative to yields on treasuries.

Right now the valuations placed on earnings of equities are at extreme lows relative to yields on bond markets - in particular treasuries. There have been three times in the last 50 years where yields on equities (the earnings of the S&P 500/the S&P 500 price level - the inverse to the P/E ratio) less the yield on the US 10yr have been above 5%. The first was in 1974, at the end of a savage bear market, the second occurred during the GFC, and the third time is now!

Yield Differential Between S&P 500 and the US 10yr (long term)

However, the yield differential isn't where it ends. This is the longest time in the last 50 years (and that is only as far back as Bloomberg's data goes) where the yield differential has been in excess of 5%(7 months to be precise). During the Global Financial Crisis (NYSE:GFC) of 2008-2009 the yield differential went above 5% for about 5 months. It is difficult to comprehend that world financial markets are in a state of disarray more or less equal in magnitude to the GFC some three years ago! But that is exactly how equity markets are being priced relative to treasury markets right now!

Yield Differential Between S&P 500 and the US 10yr (2006-present)

What about the bear market of 1974? Well the yield differential went above 5% for 6 months. For those analysts that are saying we are going to head into a state of "stagflation" (call it what you will) like that of the 1970s well guess what - this is what has already been priced into financial markets!

Yield Differential Between S&P 500 and the US 10yr (1972-1976

As I have been saying for the last 7 months - in order for you to make money by being bearish on equities and bullish on treasuries something worse than what we have seen over the last 50 years (at least) has to occur. Yes something worse than the GFC has to occur. As far as I am concerned this is a very tall ask because the GFC was the greatest financial crisis to occur this side of The Great Depression.

I think that this is one of the best times to be investing in the equity market in at least a generation. As I have been saying for the last three years (look at all my previous posts at seekingalpha.com over the last three years), continue to see any weakness in equities as a buying opportunity. We are still in the early stages of a multi-year bull market.

Source: Equities Remain In An Extreme Oversold Condition