Goldman portfolio strategists Peter Oppenheimer and Matthieu Walterspiler are out with a doozy of report, basically presenting a big bullish case for stocks, relative to bonds.
Undoubtedly this is going to be the story of the day, and will be discussed quite heavily.
The report is titled The Long Good Buy; the Case for Equities, and it essentially makes an equity-risk premium argument that stocks are just impossibly cheap relative to bonds, and that the scenario currently being priced into the markets is just unrealistically negative… even with the bug runup in stocks since early 2009.
This piece of history that Oppenheimer and Walterspiler present offers the backbone of the case:
In 1956, George Ross Goobey, the general manager of the Imperial Tobacco pension fund in the UK made a controversial speech to the Association of Superannuation and Pension Funds (ASPF) arguing the merits of investing in equities to generate inflation linked growth for pension funds. He became famous for allocating the entirety of the funds investments to equities, a move
that is often associated with the start of the so-called ‘cult of the equity’.
Prior to this, equities were largely seen as volatile assets that achieved lower risk adjusted returns than government bonds and, consequently, required a higher yield. As more institutions warmed to the idea of shifting funds into equities, partly as a hedge against inflation, the yield on equities declined and the so-called ‘reverse yield gap’ was born. This refers to the fall in dividend yields to below government bond yields; a pattern that has continued, in most developed economies, until recently.
In his speech to the ASPF, Ross Goobey talked about the long-run historical evidence that the ex-post equity risk premium was positive and that investors ignored this at their own peril.
Photo: Goldman Sachs
The long-run performance of equities was much greater than for bonds having adjusted for inflation. As he said: ‘I know that people will say: ‘Well, things are never going to be the same again’, but … it has happened again, and again. I say to you that my views are that it is still going to happen yet again even though it may not be the steep rises which we have had in the past.’ Over the 50 years that followed Mr. Ross Goobey’s pitch, his predictions proved very successful. The annualized real return to US equities (as a proxy) between 1956 and 2000 were 7.4%.
But things have changed since the start of this century and the collapse of equity markets following the bursting of the technology bubble. In this post bubble world valuations fell from unrealistically high levels. But the decline of equity markets continued well after most equity markets returned to more
‘normal’ valuations. The onset of the credit crunch, and the deleveraging of balance sheets in many developed economies that followed this have punctured the confidence that once surrounded equities, and the pre-1960s scepticism about equity returns has returned. Dividend yields are once again above bond yields and both historical, and expected future returns have collapsed.
Exhibit 3 shows the ex-post equity risk premium in the US achieved from different starting dates. Seen against the long-run history, the experience post 2000 has been dismal.
Photo: Goldman Sachs
This argument is just the tip of the iceberg, but after about 40 pages of analysis and 76 charts, the argument boils down to:
The prospects for future returns in equities relative to bonds are as good as they have been in a generation.
UPDATE: It’s worth adding that this case isn’t just about relative valuation between stocks and bonds.
There’s also a compelling growth case made in the report.
As you can see in this chart, the coming decade will be the best decade for growth since 1980, and better than any decade up until 1950.
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