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Imagine there were only two restaurants in your town: one that would sell you a pizza for $100 and the other would sell you a burger for $50. What would you do? Probably stay at home and make yourself a ham sandwich. Similarly, if stocks are priced in to lose 25% of their value, the fact that bonds are 50% overvalued is hardly a compelling reason to buy stocks. Investors would be better off to stay at home and have another ham sandwich.

For those people who believe that dividend stocks are an alternative income investment to bonds, let's take a look at the numbers:

Current Coupon / Dividend Yield

Historical Yield

Overvalued

10 Year Treasuries

1.75%

4.64%

63%

S&P 500

2.08%

4.46%

53%

Not a very encouraging argument for stocks, as both asset classes would have to suffer serious declines in price to reach their historical average yields.

However, let's forget income for a minute and take a brief look at another argument: that the earnings yield of the stock market is much higher than bond yields which makes stocks very undervalued. That is true but we need to remember that the stock market is (supposedly) a forward-looking system and that most equity investors have a holding period measured in years.

We really only have two scenarios for the midterm. The first is that interest rates begin to normalize, which will lower the spread between earnings and bond yields and cause the market to value stocks less. The other scenario, which is oddly touted by the bulls, is that our benevolent masters at central banks across the world will artificially hold interest rates low for the rest of the decade. While that is sadly possible, this scenario will only come to pass if the global economy can't return to growth on its own. Expecting a deflationary depression is a bullish argument for stocks? That doesn't sound quite right to me.

Please note that I am not arguing that the stock market is 53% overvalued, or really that it is overvalued at all. I am trying to show that the argument that bonds make stocks cheap is fallacious. The investing myth here is that relative values matters: it doesn't. Absolute value is all that matters.

Source: Bonds Do Not Make Stocks Cheap