Don't expect stocks to beat bonds

By Mark Hulbert

The equity premium is overdue to become very negative

Don't be surprised if bonds far outpace stocks over the next several years.

That's because the period since March 2020 has experienced just the opposite, and history teaches us that the equity premium (the amount by which stocks beat bonds) regularly swings from one extreme to the other. And over the 41 months since March 2020 this premium has been very extreme: You have to go back to the 1950s to find another occasion when the S&P 500 SPX over a 41-month period beat intermediate-term Treasurys by more than today's margin.

This mean-reverting tendency of the equity premium is plotted in the accompanying chart. To quantify this tendency, I focused on the 99 individual months since the 1870s in which the trailing 41-month equity premium was as large as it is today. (Data were courtesy of Yale University's Robert Shiller.) Over the 41 months subsequent to these months, stocks lagged behind bonds 74% of the time. And not by just a little bit, either: On average across all 99 months in this subset, the equity premium over the subsequent 41 months was a negative 6.0 annualized percentage points.

That's a huge margin, needless to say. Imagine how terrible it will feel for stocks to lag bonds by 6% not just for one year, but on an annualized basis for the next 3-1/2 years--until year end 2026, in other words.

How valuation models stack up currently

We might be able to wriggle out from underneath this very bearish message if other long-term valuations models were telling a more bullish story. But they're not, as you can see from the table below. It reports the current status of the eight valuation models that my research has found to some of the best records forecasting the S&P 500's return over the subsequent decade.

Notice that, with only a few exceptions, the stock market currently is more overvalued than in more than 90% of the months over the last several decades.

                                     Latest  Month ago  Beginning of year  Percentile since 2000 (100% most bearish)  Percentile since 1970 (100% most bearish)  Percentile since 1950 (100% most bearish) 
P/E ratio                            24.02   25.19      22.23              68%                                        79%                                        85% 
CAPE ratio                           30.27   31.74      28.32              81%                                        85%                                        89% 
P/Dividend ratio                     1.56%   1.52%      1.74%              86%                                        89%                                        92% 
P/Sales ratio                        2.44    2.56       2.19               90%                                        96%                                        97% 
P/Book ratio                         4.19    4.39       3.75               93%                                        93%                                        95% 
Q ratio                              1.80    1.89       1.58               93%                                        97%                                        98% 
Buffett ratio (Market cap/GDP)       1.64    1.73       1.46               92%                                        97%                                        97% 
Average household equity allocation  46.2%   46.2%      44.9%              92%                                        92%                                        94% 

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.

-Mark Hulbert

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09-02-23 0825ET

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