San Francisco Fed says stocks are a bargoon here, on the basis that they carry hardly any more risk than bonds -
From the SF Fed August 5th commentary:
Equity prices were down sharply in the month of July, although they have recovered somewhat this week. On net, the S&P 500 fell 7.9 percent to close at 912 in July, and the tech-heavy NASDAQ fell 9.2 percent to close at 1328. Ongoing accounting and corporate governance concerns led to widespread pessimism in the stock market. Nevertheless, if you are willing to believe the numbers in reported earnings, corporate earnings seemed to have bottomed out. The S&P 500 operating earnings are projected to increase by 13.6 percent in Q2 on a sequential basis, and 36.7 percent on a year-over-year basis.
With the big drop in equity prices, the question is: does the current valuation look reasonable? Using the 2002 estimated earnings, the S&P 500 is currently selling at a Price-Earnings ratio of 25.1. If we use the higher 2003 estimated earnings, it brings the P/E ratio down to 21.4.
In contrast, over the past 75 years, the S&P 500 P/E ratio averaged 15.2. One way to put today's valuation into perspective is to invert the P/E ratio to get the earnings-price ratio, which measures the earnings yield from holding stocks. The earnings yield for the S&P 500 is currently 3.98 percent based on 2002 earnings estimates, and at 4.67 percent using the 2003 earnings estimates. Compared to the real return from holding a AAA-rated corporate bond, which is currently at 4.13 percent, the equity premium is only about zero to 50 basis points, as compared to an average of 2 to 3 percent in the past.
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