Stock vs Bond Conundrum Amidst Sky High Buffet Indicator

By the Curmudgeon with Victor Sperandeo

Equity–Bond Valuation Dislocation:

Bonds can’t get any respect (no satisfaction), as equity indexes soar ever higher with no end in sight?

For decades, financial theory has held that equities should offer a higher earnings yield [1.] than U.S. government bond yields, compensating investors for exposure to earnings volatility and cyclical risk. Empirically, this relationship has been robust: between 1990 and 2026, the U.S. equity earnings yield exceeded the 10-year Treasury yield by approximately 230 basis points on average, based on a simple earnings-to-price framework as reported by Smith Affiliated, a New York investment adviser.

Note 1. The earnings yield is the inverse of the S&P 500 P/E ratio using trailing 52-week EPS.

That relationship has now inverted. As of early June, the S&P 500 earnings yield stood near 3.6%, roughly 85 basis points below the 10-year Treasury yield. Financial logic has been turned upside down.

More sophisticated approaches, such as JP Morgan’s dividend discount model, convey a similar signal. The equity risk premium has compressed materially from its long-term norm of roughly 5%, leaving equities appearing very expensive both on an absolute basis and relative to fixed income.

Image Credit: © Efi Chalikopoulou via the Financial Times

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The trailing 52- P/E ratio of the S&P 500 is ~25.11 so the reciprocal earnings yield is ~3.98% while the U.S. 10-year yield is now ~ 4.5%. That translates into a negative equity risk premium of -0.58%.

JP Morgan’s models say that “equities look rather expensive--on an outright basis relative to the norms of the past 30 years.” And “equities currently look even more expensive relative to bonds,” according to the investment bank.

This negative equity risk premium inversion is atypical. Rising interest rates would normally exert downward pressure on equity valuations while simultaneously enhancing the attractiveness of bonds. Yet U.S. equity markets—led by a narrow cohort of large-cap AI related technology stocks—have remained resilient.

Victor's Thoughts on Bonds vs. Stocks:

The U.S. bond market is the life blood of the fiat money system we live under. Bonds, notes, and other interest rate sensitive securities are what Baron Rothchild said [1.] to buy under distressed conditions like now.

What is critical to me is what new Fed Chairman Warsh says about money supply at the end of Wednesday's FOMC meeting.

Note 1. Following the 1815 market panic after the Battle of Waterloo, Rothchild supposedly said, “Buy when there’s blood in the streets, even if the blood is your own.” This quote gained popularity decades later because it encapsulates a bold, contrarian investment strategy.

Meanwhile, stocks are the "Tulip Bulbs" [2.] of our time. At the end of June, the U.S. will start the 18th year without a recession. Even if the Strait of Hormuz is open soon it will take many months to ship oil to its designated destination. Spending on data centers will slow, consumer spending will slow, and the economy will weaken. Thereby, stocks are at remarkably high risk in all manners of analysis.

Note 2. Tulip Mania was a period in the 17th century Dutch Republic when the prices for tulip bulb reached extraordinary unsustainable levels before crashing. It was the first speculative bubble in history.

Explanations for Bond vs. Stock Divergence:

Bond market mispricing: This would imply a sharp decline in inflation, meaningful fiscal consolidation, or an impending recession. Current macro data, however, offer limited support: inflation remains above target, growth is stable, and fiscal deficits are expanding.

Equity market overvaluation: This appears more plausible. Recent market performance has been heavily influenced by AI-driven optimism, despite limited near-term earnings realization. At the same time, capital supply dynamics are shifting, with increased Treasury issuance (estimated at up to $10 trillion over the next year) and a potential resurgence in IPO activity.

Structural regime uncertainty: A third, less quantifiable explanation is that traditional valuation frameworks are under strain. Investors are navigating a transition from a decades-long regime characterized by globalization, low inflation, and abundant liquidity toward one defined by geopolitical fragmentation, fiscal expansion, and uncertain AI-driven productivity outcomes.

Importantly, the equity bull case remains intact in key respects. Earnings growth outside the technology sector has been resilient, and forward-looking expectations for AI-driven productivity gains are increasingly embedded in valuations.

From this perspective, it is plausible to argue that bonds—not equities—are mispriced, particularly if long-term growth accelerates and inflation moderates.

The durability of this valuation dislocation is uncertain. Historical precedents suggest such divergences can persist longer than expected, as seen during the late-1990s equity bubble or the extended period of suppressed yields in the post-global financial crisis era.

Ultimately, investors are confronted with a fundamental allocation question: whether to anchor expectations on fiscal and monetary normalization, or on a structurally higher growth trajectory driven by technological innovation. The answer will be decisive in determining relative asset performance in an environment where capital may once again become scarce.

Fixed Income Positioning:

Both Victor and the Curmudgeon prefer 5–to-7-year U.S. notes, where yield pickup over T-bills compensates for modest duration risk.

· The Curmudgeon has built a laddered portfolio of 2, 3, 5 and 7- year notes at auction via the Treasury Direct website.

· Victor is long 5 Year U.S. T-note futures.

We both expect the U.S. economy to weaken, independent of the outcome of the Iran conflict.

Warren Buffet’s Favorite Indicator: Total U.S. Stock Market Value/ U.S. GDP:

The Buffett Indicator, also known as Market Cap to GDP ratio, has gained prominence as a long-term valuation indicator for stocks, largely due to Warren Buffett's endorsement. In a 2001 Fortune Magazine interview, Buffett referred to it as "probably the best single measure of where valuations stand at any given moment." This statement has drawn attention to the indicator's potential significance in assessing market conditions. By comparing the stock market's size to the overall economic output, this ratio provides insights into the relative valuation of the market.

As of June 12, 2026, the Buffett Indicator=233.8%. The Total Market Index (Wilshire 5000) is at $ 74397.5 billion, which is about 233.8% of the last reported GDP.

As you can see from the graph below, the indicator is off the charts, at an all-time high, and significantly higher than the dot com bubble top in early 2000.

Importantly, the Buffet Indicator is now 746.73% higher than it was at the August 1982 bear market bottom. It was 31.31 on Aug 11, 1982 vs 233.8 as of Friday's close. To get back to that 1982 level it would take an 86.61% decline in the indicator (233.8 - 31.31 = 202.49/233.8= 86.61%).

What do you think would happen to the global economy if the U.S. total stock market capitalization dropped by 86.61%?

Victor's Conclusions:

The U.S. and Iran are negotiating a two stage Memorandum of Understanding (MOU) to end the Iran conflict. Trump needs a way out of this fine mess he got himself into, and this MOU would be an exit strategy for the U.S. As oil prices decline, so will the CPI which will lead to lower interest rates, and a grand rally in what is now 100% out of favor- debt investments.

News Flash -Trump says a "deal" with Iran has been reached:

“The Deal with the Islamic Republic of Iran is now complete,” Trump wrote Sunday on Truth Social. “Congratulations to all! I hereby fully authorize the toll-free opening of the Strait of Hormuz, and, simultaneously herewith, authorize the immediate removal of the United States Naval blockade. Ships of the World, start your engines. Let the oil flow!”

Pakistani Prime Minister Shehbaz Sharif, whose country has helped mediate talks, said a deal was reached and there will be an official signing ceremony in Geneva, Switzerland on Friday. "Both sides have declared the immediate and permanent termination of military operations on all fronts, including in Lebanon," he said, adding that mediators this week will facilitate meetings to "lay the foundation for the technical talks."

It’s not yet clear whether the deal includes an agreement for Iran to abandon its nuclear program and allow its enriched uranium to be removed from the country, as Trump has demanded. In reality, nothing will be known about this "deal" till the Friday signing, if it actually occurs.

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End Quote:

"Wall Street sells stocks and bonds, but what it really peddles is hope,” Jason Zweig, Wall Street Journal columnist.

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Wishing you good health, success, and good luck. Till next time........

The Curmudgeon
ajwdct@gmail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever-changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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