Are Equity Risk Premiums of Any Help to Investors ? Not so sure…

Source: Goldman Sachs

Source: Goldman Sachs

From GS’s latest GOAL publication:

« Much of the reason that equities appear cheap versus bonds therefore is simply a reflection of how much bond yields have fallen. Most measures of the ERP will use some kind of long-run historical average measure of profit growth and extrapolate into the future. »

Current levels of ERP assumes that earnings growth of the past 20 years will go one forever. But that’s a hard case to make. In fact, as GS’s strategists put it:

« Here lies the great dilemma for investors: on the one hand, current bond yields imply that valuations can continue to rise for financial assets (as they have already done over recent years), but, on the other hand, to justify current risk free rates into the future, we should assume lower long-term growth (consistent with ‘secular stagnation’).This should cap the level of valuations close to current levels.This is why we argue that while the Long Good Buy for equities still holds – they should do well relative to bonds over the medium term – the market trajectory is likely to be flatter than experienced through 2009 to 2016. »

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