The difference between equity earnings yields and bond yields is a poor predictor of market returns over a one-month period, explaining only 10% of the outcome. However, its predictive power increases dramatically over a three-year horizon, where it explains roughly half of the result, highlighting its utility for long-term strategy, not short-term trades.
Higher bond yields theoretically devalue stocks by increasing the required rate of return for investors. However, current markets are seeing this effect counteracted by strong corporate profit growth, which works in the opposite direction within valuation models like the dividend discount model, ultimately supporting stock prices.
Conventional wisdom suggests investors would sell stocks to buy more attractive, higher-yielding bonds. However, current market data shows capital flowing into both asset classes. Furthermore, their positive day-to-day correlation indicates investors are not treating them as simple substitutes, which challenges typical asset allocation assumptions.