The Earnings Yield Coverage Ratio Drops to 0.99 it is Time to Sell Stocks - Rebalance AND Re-Think Stock/Bond Allocation

J. Paul Getty Quote!

Stock Market - "For as long as I can remember, veteran businessmen and investors - I among them - have been warning about the dangers of irrational stock speculation and hammering away at the theme that stock certificates are deeds of ownership and not betting slips.

The professional investor has no choice but to sit by quietly while the mob has its day, until enthusiasm or panic of the speculators and non-professionals has been spent. He is not impatient, nor is he even in a very great hurry, for he is an investor, not a gambler or a speculator.  There are no safeguards that can protect the emotional investor from himself."

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Common Sense Investing:

The Papers of Benjamin Graham

Benjamin Graham

Over a ten-year period the typical excess of stock earnings power over bond interest may aggregate 4/3 of the price paid. This figure is sufficient to provide a very real margin of safety--which, under favorable conditions, will prevent or minimize a loss......If the purchases are made at the average level of the market over a span of years, the prices paid should carry with them assurance of an adequate margin of safety.  The danger to investors lies in concentrating their purchases in the upper levels of the market.....

Central Concept of Investment for the purchase of Common Stocks.

"The danger to investors lies in concentrating their purchases in the upper levels of the market..."

Stocks compared to bonds:

Earnings Yield Coverage Ratio - [EYC Ratio]

EYC Ratio = [ (1/PE10) x 100] x 1.075] / Bond Rate

1.75 plus: Safe for large lump sums & DCA

1.30 plus: Safe for DCA

1.29 or less: Mid-Point - Hold stocks and purchase bonds.

1.00 or less: Sell stocks - rebalance portfolio - Re-think stock/bond allocation.

Current EYC Ratio: 0.99

As of 6-1-15

PE10 as report by Multpl.com

Bond Rate is the rate as reported by

Vanguard Long-Term Investment-Grade Fund Investor Shares (VWESX)

DCA is Dollar Cost Averaging.

PE10  .........27.19
Bond Rate...3.99%

DYI Comments:  Stocks have been on a tear since they bottomed in March of 2009, however they now have out done themselves pushing our EYC Ratio below one at 0.99 indicating re-balancing and/or re-thinking stock/bond allocation.  This is an overblown and overvalued market.  What has kept it moving up for much longer than history would suggest has been three events.  One: 1st world Boomer generation is in their peak savings years and are desperate for yield to provide for retirement needs.  Anything with a decent dividend yield or interest rate they are buying.  This buying power (appx. 125 million Boomer's) combined with (pt.#2) Central Banks dropping their rates to sub atomic low rates to thwart the effects of the Great Recession pushing basic bank savers into stocks and bonds. The speculative juice has been provided by the unexpected drop in oil/gas prices.  This has extended the stock/bond rally so much so that I labeled this period of time "The Great Wait."  The effects of that drop will wear off in due time and more importantly the effects priced into the market.

Below are a few additional charts illustrating how far we have come.  Don't get caught thinking you can hold out longer for a few extra percentage gains as they will be transitory when the bear appears.

 

When Paper Wealth Vanishes 

John P. Hussman, Ph.D.

Presently, the valuation of the S&P 500 is within about 16% of the 2000 peak, on the most historically reliable measures we identify. Moreover, valuation extremes were only greater in 2000 on capitalization-weightedindices. Today, the median stock is more richly valued than at any point in U.S. history, including 2000. The following chart is perhaps one last look – unless market internals reverse course – at the extreme to which Fed-induced yield-seeking speculation has taken equity valuations. Market capitalization to national gross value added – a measure that I introduced a few weeks ago (see The “New Era” is an Old Story) – is better correlated with actual subsequent market returns than any widely followed valuation measure we’ve examined, including price/forward operating earnings, the Fed Model, the Shiller P/E, Tobin’s Q, market capitalization to GDP, and others. The following chart shows a weekly conversion of quarterly data, using the S&P 500 to proxy intra-quarter market fluctuations (adjusting for intra-quarter changes in GVA would have negligible impact).

The next chart shows the relationship of this measure to actual subsequent nominal annual total returns in the S&P 500 Index over the following decade (shown this time on an inverted log scale, alongside actual subsequent market returns). From current valuations, this measure implies that equities are likely to lose value, including dividends, over the coming decade. As we saw in the decade following the 2000 peak, we expect the equity market to experience much more severe interim losses along the way.

DYI