Bonds Vs. Stocks: A Historical View by Tom Hayes
Relative value is a familiar buzzword when it comes to comparing bonds and stocks. But is it accurate? There are criteria that must be specified for comparisons, as Tim Hayes of Ned Davis Research Inc. points out; for one, the time periods the comparisons are drawn from.
So what's a better value, stocks or bonds? This common question is often answered by comparing
relative yields. When bond yields are high relative to stock yields, they can be expected to eventually
drop back toward a more normal level relative to the stock yields. Thus, bonds can be considered a
relatively good value when bond yields are judged as being too rich and poised to drop.
But a significant question must be answered when such comparisons are made: What's the norm? In
recent years, comparisons have been made using data starting in the early 1960s. Using Moody's Aaa
bond yields to represent the bond yield and the Standard & Poor's 500 earnings yield to represent the
stock yield, the mean bond yield to stock yield ratio since December 1959 has been 1.14 (Figure 1). With
the current ratio at 1.60 as of October 1993, an argument could be made that bonds are close to losing
their valuation advantage.