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Equities continue to rally despite economic data reminiscent of the Great Depression. This chart from Credit Suisse global equity strategist Andrew Garthwaite provides the best explanation for why.

Mr. Garthwaite emphasizes that inflation-adjusted 10-year U.S. Treasury bond yields are currently negative, meaning that buyers lose money while holding the asset.

This leaves investors with no choice but to buy equities, and stock prices and price-to-earnings ratios have climbed in proportion to the extent that real yields have fallen. (Note that real yields have been plotted inversely on the chart to better show the trend – a rising purple line indicates falling inflation-adjusted yields).

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Low bond yields driving equities higher

S&P 500

forward P/E ratio

Inflation-adjusted

10-year U.S. Treasury

bond yield (inverted, %)

26

-0.8

-0.6

24

-0.4

-0.2

22

0.0

20

0.2

0.4

18

0.6

16

0.8

1.0

14

1.2

12

1.4

2015

2016

2017

2018

2019

2020

THE GLOBE AND MAIL, SOURCE: scott barlow;

credit suisse; bloomberg

Low bond yields driving equities higher

S&P 500

forward P/E ratio

Inflation-adjusted

10-year U.S. Treasury

bond yield (inverted, %)

26

-0.8

-0.6

24

-0.4

-0.2

22

0.0

20

0.2

0.4

18

0.6

16

0.8

1.0

14

1.2

12

1.4

2015

2016

2017

2018

2019

2020

THE GLOBE AND MAIL, SOURCE: scott barlow;

credit suisse; bloomberg

Low bond yields driving equities higher

S&P 500 forward P/E ratio

Inflation-adjusted 10-year

U.S. Treasury bond yield (inverted, %)

26

-0.8

-0.6

24

-0.4

-0.2

22

0.0

20

0.2

0.4

18

0.6

16

0.8

1.0

14

1.2

12

1.4

2015

2016

2017

2018

2019

2020

THE GLOBE AND MAIL, SOURCE: scott barlow; credit suisse; bloomberg

Mr. Garthwaite believes the equity rally has a long way to run. He expects real Treasury yields to fall much further from current levels near minus 0.4 per cent as a slow post-pandemic economic recovery depresses growth forecasts. His prediction of minus 2 per cent for inflation-adjusted yield implies a trailing P/E ratio between 40 and 60 times for U.S. equities, similar to the technology bubble of the late 1990s.

Morgan Stanley U.S. equity strategist Michael Wilson has a similar justification for rising stock prices (not shown on the chart).

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Mr. Wilson calculated that the estimated earnings yield on the S&P 500 – consensus profit forecasts for the next 12 months divided by the index level – exceeded the yield on the 10-year Treasury bond by more than seven percentage points on March 23. The last time this occurred was March, 2009, the beginning of the post-financial crisis market rally.

In slightly different ways, both strategists agree that the equity market rally is driven less by the attractiveness of stocks themselves amid pandemic-related uncertainty, and more because the minuscule available returns in bond markets are driving new money toward the S&P 500.

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