In this brief posting, I am going to take a quick look at the yield differential between Earnings Yield of FBMKLCI (i.e the inverse of FBMKLCI’s price-to-earnings ratio) and yield to maturity (YTM) of 5 Year AAA-rated private debt securities (PDS). The lower amount of yield differential (earnings yield minus PDS yield) may potentially indicate a higher risk of equity overvaluation.
The following graph shows the historical trend between earnings yield (FBMKLCI) and yield to maturity (5Y-AAA), whereby the earnings yield of FBMKLCI is usually at a premium to the YTM of 5YAAA:
The following graph shows historical trend of yield differential. FBMKLCI is currently trading at yield differential of 1.66% (premium) which is relatively lower than historical median yield differential of 1.92% (premium):
The following graph shows the historical distribution of yield differential with a mean of close to 2.0% premium:
In a nutshell, based on the above hypothesised relationship (between earnings yield of FBMKLCI and YTM of 5YAAA), the FBMKLCI may not appear to be ‘overvalued’ as the current yield differential is not overstretched from its historical mean / median. Nevertheless, there are certainly other factors to be considered in determining whether an equity market index is overvalued or not. This positing is strictly for educational & illustrative purposes only.
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