Investors and advisers use price to earnings (P/E) ratios as a measure of valuation for companies. It is one way to measure if an investment is over- or under-valued. The chart above shows the historical comparison of the S&P 500 P/E ratio to the 10-yr Treasury bond P/E ratio for the last 55 years. What is most interesting about the chart is the divergence of the S&P 500 P/E and the 10-yr Treasury bond P/E during the last 9 years. While stocks, as a whole, have remained around the average of 20, bonds have had dramatic swings up and down, ending the 3rd quarter of 2017 at 42.8.
There has been much discussion in the financial press about the idea of stocks being expensive compared to long term averages. While it is true that stock P/E ratios (as represented by the S&P 500) are in fact moderately above historical averages – currently around 20 for the S&P 500 versus an average of 16.65 since 1962 – that moderately elevated level pales in comparison to that of bonds. The P/E ratio of the 10 year Treasury bond is currently around 42.8 – more than double the long term historical average of 20.55. At Tradition we feel that bonds are grossly overpriced and potentially in bubble territory – which leads to the question: “If stocks are somewhat expensive, and bonds are very overpriced, where should I be investing my money?” It is our thought that diversifying assets present a more attractive investment opportunity than long term bonds at this time. You can read more about how diversifying assets may serve as a fixed income substitute by reading about our Absolute Income strategy.
DISCLAIMER: Tradition Capital Management, LLC. is an SEC (Securities and Exchange Commission) Registered Investment Adviser under the Federal Investment Advisers Act and provides portfolio management and related services for a fee. Nothing should be considered a solicitation to buy or an offer to sell shares of any security or service in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction. Investing in stocks and other risk assets could result in losses and positive returns are not guaranteed; at any given time, any asset class or asset may lose money and result in loss of principal value. Asset allocation and diversification may potentially mitigate some losses but does not ensure a profit nor fully protect against losses in declining markets. Inflation and liquidity risks are additional risks for financial assets. Diversification only reduces risk of capital loss but does not eliminate these risks. Past performance is no indication to future results, and all investments could lose value in the future.
Tradition does not make any assertions, estimates or guarantees about future results. The above is for illustrative purposes only to show possible return profiles of various asset classes and is not a depiction of historical returns nor is it a projection of future returns. This illustration is not GIPS compliant and is shown only for illustrative purposes. Expected Returns and Expected Yields are not forecasts nor guarantees, but are merely reasonable long term goals for strategies and asset classes and are used for modeling purposes. Actual results could vary materially from these Expected Returns and Yields and may provide positive or negative returns that may vary widely from these Expected Return and Expected Yield means (averages).