Are Equities Attractive?

Brad DeLong thinks that stocks look attractive over the long run, and has written a paper to that effect:

As of this writing the annual earnings yield on the value-weighted S&P composite index is 5.53%. This is a wedge of 3.22% per year when compared to the annual yield on 10-year Treasury inflation-protected bonds of 2.31%. The existence of the equity return premium in the past offered long-horizon investors a chance to make very large returns in return for bearing little risk. It appears likely that the current configuration of market prices offers a similar opportunity to long-horizon investors today.

One person who doesn’t agree with him is Albert Edwards:

What does it mean if real bond yields fall? It means that expectations of real growth in the economy have declined. And if that is the case, then expectations for profits growth should have fallen in line (since profits cannot, in the long run grow faster than the economy). So lower real yields shouldn’t help equities either.

There is a good practical example of this issue in Japan. Japanese government-bond yields fell steadily through most of the 1990s, bottoming out at 1-2%. The earnings yield has been higher than the government bond yield throughout this decade, but that has not made the Tokyo stockmarket a good buy.

Most people are going to continue to invest their long-term savings in stocks either way, at least in the US. That’s good news if DeLong is right; it could be slowly devastating if Edwards is right.