Valuing the Market Using the Earnings Yield

Chart of the Week for October 8-14, 1999

The S&P 500 earnings yield is the earnings of the securities in the S&P 500 Index divided by price. This is the inverse of the well-known price to earnings ratio. The earnings yield is a gauge to evaluate the return to the investor in the form of earnings, relative to current stock prices. As the chart above illustrates, the S&P 500 earnings yield is near an all-time low (going back to 1965).

In June 1999, the S&P 500 earnings yield reached its low of 2.88%. Because stock prices have fallen since then, the earnings yield has drifted up slightly to 3.34%, but remains at the bottom of its historical range. Thus, from this measure of value, stocks are currently overpriced.

It is also possible to view the relative attractiveness of stocks versus bonds when comparing the S&P 500 earnings yield to the yield on the 10-year Treasury note. When the spread between the two yields widens (i.e. when bonds yields are higher than the earnings yield), bonds become more attractive relative to stocks. On September 30, the 10-year Treasury yielded 5.88%, so the spread was 2.5%, compared to an average spread over the entire period charted of 0.6%.

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