Stocks versus bonds is a no-brainer for the next decade, says the Fed model

Still, some may be wondering if U.S. stocks are just a bit too expensive right now when investors can get a 4%-plus yield from 10-year Treasurys. In our call of the day, Joachim Klement, head of strategy at London-based Liberum Capital, sticks up for stocks.

First, he explains why investors might think the opposite. “If you look at the 7-year return forecasts of GMO below, you could be forgiven if you decided to sell all your U.S. stocks and hold just U.S. bonds,” Klement says in his substack post, offering this chart:

“After all, the S&P 500 is trading at 20x [times] forward earnings, and other valuation metrics light up amber, if not red as well.”

But then Klement does a “sense-check” of those forecasts against the Fed model, a popular market-timing tool used to gauge whether stocks are over or undervalued. (The term “Fed model” was coined after testimony by former Fed chair Alan Greenspan.) It compares earnings yields for equities against real bond yields for government bonds.

He says it’s important to use a real bond yield, and not a nominal one that changes with inflation.

So if the earnings yield of the stock market is low versus the real bond yield, one would assume stocks are pricier. And starting with a relatively more expensive equity market, investors would be forgiven for expecting to get lower, even negative, returns for equities versus bonds, he says.

But here’s what happen when Klement uses the Fed model to map out relative returns for U.S. stocks versus bonds:

He offers up a similar chart for U.K. stocks and bonds using the Fed model. For both, he included current starting values of the difference between earnings and real bond yields.

“And though the U.S. equity market is expensive while the U.K. equity market is cheap (trading at c.10.5x forward earnings) both charts come to a similar conclusion. Based on the historic relationship shown in these charts, we would expect stocks to outperform bonds by about 4.5% per year over the coming decade,” says Klement.

Note, not everyone agrees that the Fed model is the best way to value stocks. Some point out that it missed some big downturns, such as the 2008 recession.

The markets

S&P 500
ES00,
+0.05%
and Nasdaq-100 futures
NQ00,
-0.04%
are flat, with Treasury yields
BX:TMUBMUSD10Y

BX:TMUBMUSD02Y
softer. Oil prices
CL.1,
+1.31%
are nudging higher. In Asia, the Hang Seng
HK:HSI
rose nearly 2%. Europe stocks
XX:SXXP
are slipping ahead of an ECB meeting where rates aren’t expected to budge from record highs.

The buzz

A first look at fourth-quarter gross domestic product is due at 8:30 a.m., alongside weekly jobless claims, durable-goods orders and advanced trade in goods. New home sales are expected at 10 a.m. Follow all the action in MarketWatch’s Live Blog.

Tesla
TSLA,
-0.63%
stock is tumbling 7% after the EV maker warned of “notably lower” growth this year as it focuses on its next generation car, and earnings fell short.

Opinion: Elon Musk wants voting control of Tesla’s stock, but won’t admit it to investors

IBM
IBM,
-0.01%
is up 7% after a forecast-beating profit and talk of higher AI demand. Nokia stock
NOK,
+1.49%

NOKIA,
+7.48%
is rallying after a margin beat.

Northrop Grumman
NOC,
-0.85%,
Dow
DOW,
-1.52%,
Southwest Airlines
LUV,
,
American Airlines
AAL,
-0.50%
and Union Pacific
UNP,
-0.41%
will report ahead of the open. Intel
INTC,
+0.41%
(see preview), Western Digital
WDC,
+0.52%
and Visa
V,
+0.14%
are due after the close.

Boeing
BA,
+1.24%
stock is down 2% after the FAA halted its plans for expanding Max airplane production following an in-flight blowout, though it approved an inspection process to get grounded jets flying again.

Banks are now losing out on a big arbitrage play thanks to the Fed.

Time is ticking for Nikki Haley and the big donors keeping her in the fight for the 2024 Republican presidential primary.

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The chart

Record highs for stocks? Great news.

“Not so great is that bullish sentiment remains high. The two bull/bear ratios we monitor remain elevated (chart). From a contrarian perspective, that’s bearish,” Yardeni Research’s Ed Yardeni tells clients, and offers the below chart:

Note, Yardeni is the most bullish analyst on Wall Street, with an end-year S&P 500 target of 5,400.

Top tickers

These were the top-searched tickers on MarketWatch as of 6 a.m.:

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