The guest commentary below was written by Tim Boyd. He is the Chief Investment Officer of Delphi Capital in San Diego.
Of all the fallacies currently circulating in the market, none drives us crazier than the notion that "stocks are cheap."
When Warren Buffett recently made a comment along these lines we immediately face-palmed ourselves, utterly nonplussed that a legend of finance could buy into such tripe.
The shtick is based on the so-called Fed Model and goes something like this:
"The earnings yield on the S&P 500 should trade in symbiosis with the yield on the 10-year Treasury. The earnings yield has badly lagged the drop in bond yields over the last 18 months, ergo stocks are cheap."
First, let us say this: the Fed Model is a great intermarket analysis framework, one that harmonizes nicely with modern portfolio theory.
Now we'll say this: when Treasury yields drop like stones because of "emergency monetary policy measures" and/or decelerating GDP growth amidst the biggest explosion in government debt in the history of the world, the Fed Model is nothing more than a quaint anachronism from a more reasonable/less corrupt era.
Some will argue that despite all of this, one still can't deny that stocks are cheap relative to bonds. This is, of course, just like saying that the middle-class is in great shape because it's fallen further than ever behind the upper class, which has of course benefited massively and disproportionately from a decade of monetary policy shenanigans. So no - we reject such a rejoinder as sophistry.
The fact of the matter is that the S&P 500 has only been this expensive relative to actual economic growth once in the last 30 years: at the height of the Dot-Com Bubble. And one does not need a business/finance degree to divine that the reason the S&P's market cap once again exceeds the size of the entire American economy is the aforementioned explosion in debt.
This is a Hedgeye Guest Contributor piece written by Tim Boyd of Delphi Capital. This piece does not necessarily reflect the opinion of Hedgeye.