Right now, it’s all about bond yields. The U.S. market has been extremely expensive by historical standards for several years now. Throwing out one popular valuation metric, the 10-year CAPE is sitting at 1998 levels. By some metrics (median price/sales ratio, for example), the market is the most expensive it’s ever been in history.
But as Warren Buffett has pointed out in multiple interviews, the market is not quite as expensive as it might seem at first glance when you consider how low bond yields are today.
Of course, the flip side of this becomes “What happens when bond yields start trending higher?” Suddenly, stock valuations start to matter again.
The 10-year yield has been trading in a range for several years now, with 3% being the upper limit of that range. I expect that yields will push a little over 3% before easing back into the mid 2’s. If something more or less in line with that happens, then I believe the bull market is safe and intact for the time being. Should yields push through that 3% level and keep on rising, then I think we should expect a lot more choppiness and volatility.
Other than bond yields, the economic backdrop is solid. Most of the data coming in is positive, and we haven’t seen the effects of corporate tax reform flow through to profitability yet. So, barring a quick reversal in growth (which I see as unlikely in the next 6 months) or a sharp uptick in inflation (which I also see as unlikely), the backdrop looks good for further gains.
This article first appeared on Sizemore Insights as On CNBC: What’s the Outlook for Bonds?