Whatās Going On Here?This here stock marketās had some ups and downs this year, but according to Goldman Sachs, there are still more rootinā tootinā returns to be had. Yeehaw! What Does This Mean?Goldmanās math is based on the āequity risk premiumā, or ERP: thatās the extra profit investors expect to earn from risky stocks compared to theoretically risk-free government bonds. So while stocks are currently at record highs, Goldman reckons the ERP is too ā suggesting theyāre still a better bet than bonds.
Hereās why: thereās an inverse relationship between bond yields and the ERP, so as bond yields have fallen to record lows, the ERPās climbed close to all-time highs. Whatās more, those low bond yields would ordinarily suggest investors are worried about weak future economic growth, which is usually a sign to sell their stocks. But since central banks ā which have been buying up bonds to prop up their economies, driving yields down ā are largely responsible, investors have carried on buying stocks anyway. Why Should I Care?For markets: Relationship goals.
Goldmanās worked out that, in Europe, a one percentage point decrease in bond yields theoretically adds 30% to the value of European stocks, thanks to the corresponding increase in the ERP (tweet this). That relationshipās even stronger in the US, where 90% of the ERPās rise can be explained by falling government bond yields. And given that the Federal Reserve just hinted itāll keep the USās interest rates ā and, by extension, bond yields ā low for longer, US stocks might now be even more promising than Goldman thinks.
For you personally: Thatās so next year.
Based on Goldmanās math, stocks should offer positive returns relative to bonds for the next 12 months. But in a yearās time, Goldman isnāt expecting there to be anything to choose between US stocks and bonds ā though in Europe, stocks might still be outperforming bonds. | 