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The answer is yes at face value, as the earnings yield you get from US stocks is still around 5%. The two extra percentage points you expect from holding stocks instead of bonds is slightly above the longterm average. Of course, you may wonder what would be needed to wipe out the advantage of holding stocks. The S&P 500 going above 6,000 points would do the job. But that sounds rather unlikely these days. So the more threatening scenario is that earnings and thus the earnings yield both drop. Here a 40% drop in earnings would wipe out the premia overall. Alternatively, a 20% drop or so would bring it below its long-term average. In other words, a heavy recession is needed in the first case or a mild one in the second. In contrast to these gloomy considerations, the current earnings season shows highly resilient corporate profitability, and our bond-yield models stubbornly point to muted recession risks.

Of course, you can do a much more sophisticated analysis onvaluations than the back-of-the-envelope calculations outlined above. However, the crux remains: valuations do not matter in the short run. Cheap investments can become even cheaper, overpriced ones even more overpriced. Hence the valuation needle only points to the long-term direction. As for the short run, the voting machine of investor positioning and liquidity outshine the long-term considerations of the valuation-weighing machine.

Conclusion for investors

Against this backdrop, we advise against being brave in current markets. The mood is dark but so is the liquidity squeeze we are seeing in many markets. A trigger to unwind the trouble does not seem imminent. We thus tweak our positions only marginally but err on the cautious side by downgrading consumer cyclicals in equities and upgrading European highinvestment-grade bonds. It may be wise to walk on the calm side for now.

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