Whatâs Going On Here?This here stock marketâs had some ups and downs this year, but according to Goldman Sachs, there are still more rootinâ tootinâ returns to be had. Yeehaw! What Does This Mean?Goldmanâs math is based on the âequity risk premiumâ, or ERP: thatâs 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 â suggesting theyâre still a better bet than bonds.
Hereâs why: thereâs an inverse relationship between bond yields and the ERP, so as bond yields have fallen to record lows, the ERPâs climbed close to all-time highs. Whatâs 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 â which have been buying up bonds to prop up their economies, driving yields down â are largely responsible, investors have carried on buying stocks anyway. Why Should I Care?For markets: Relationship goals.
Goldmanâs 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 relationshipâs even stronger in the US, where 90% of the ERPâs rise can be explained by falling government bond yields. And given that the Federal Reserve just hinted itâll keep the USâs interest rates â and, by extension, bond yields â low for longer, US stocks might now be even more promising than Goldman thinks.
For you personally: Thatâs so next year.
Based on Goldmanâs math, stocks should offer positive returns relative to bonds for the next 12 months. But in a yearâs time, Goldman isnât expecting there to be anything to choose between US stocks and bonds â though in Europe, stocks might still be outperforming bonds. | 