History shows us that when the risk-free asset (Treasuries, supposedly) becomes competitive with equities, stocks have to work harder to compete. This dynamic is explained by the Fed model, which compares the equity “P/E” to the bond P/E (below). Investors have to pay 22x the coupon stream to own a 10-year Treasury, equal to the 22x they have to pay for a year of earnings. Stocks are supposed to yield more than Government bonds, so the valuation question for stocks is not just one of absolute levels but also relative to bonds and cash.
History clearly shows that as bond yields rise, so does the correlation with stocks. It makes perfect sense, based on the above approach to relative value. If bonds yield 1% and going to 2%, while stocks are yielding 5%, it matters in terms of discounted cash flows, but stocks are still the superior yielding asset by far. But if bonds are yielding 5% and going to 6%, while stocks are at 5%, valuations need to adjust lower. This is classic late cycle behavior, in which robust earnings growth is offset by rate pressures.
The above dynamic may well play a role in what is now a mature secular bull market. History shows that secular bulls die in one of two ways (or both): inflation and valuation. While valuations are not quite at the extremes seen in 2000, 1973, or 1929, they are elevated at a time when bond yields have become competitive again.
Therefore, I could easily see this super-cycle’s “golden years” be a phase in which valuations go from amplifying earnings gains (as they did in 2023 and 2024) to offsetting them. It doesn’t mean the end of the bull market, but it would mark the peak of double-digit returns, which is exactly what the CAPE model says.