From Calafia Beach Pundit:
This is a follow-up to my post last week, "The importance of real yields,"
in which I compared real yields on TIPS to nominal yields on
Treasuries, real GDP growth rates, and gold. I noted that real yields
tell us several interesting things about the market's outlook: the
market does not expect any meaningful change in the rate of inflation;
the demand for safe assets is beginning to decline; and real GDP growth
rates are expected to be low for the foreseeable future.
The chart above compares the earnings yield on equities (i.e., the
inverse of the PE ratio) with the price of 5-yr TIPS (using the inverse
of their real yield as a proxy for price). It shows that when equity
valuations are high (i.e., when the earnings yield on equities is low),
the demand for safe assets is weak, and vice versa, and that makes
perfect sense. In the late 1990s, equity markets were booming, the
economy was growing at a 4-5% rate, and real yields were usually high.
During those go-go years, in other words, the demand for stocks was
strong and the demand for TIPS was weak. By the early 2010s, things had
reversed: the earnings yield on stocks had soared (corporate profits
were very strong but the market was very doubtful that those earnings
would hold up), and the demand for TIPS had soared because everyone
feared that the economy would remain weak or suffer another recession.
Over the past year, however, we have seen a divergence between these
variables. Earnings yields have declined (i.e., multiples are rising),
as the market becomes more confident in the outlook for earnings, but
real yields have been relatively flat and are still quite low. In other
words, the demand for equities is strengthening, but the demand for TIPS
is not declining....MORE
