Currently, the equity risk premium or the stock earnings yield relative to bond yields is at a positive 2.9%.
A few segments of the US stock markets have run up significantly in the last one year, but that is not enough to convince Brett Nelson, Head of Tactical Asset Allocation, Goldman Sachs that Wall Street is in the bubble territory just yet. Brett Nelson said in a recent podcast hosted by Goldman Sachs that equity risk premium is still attractive at this juncture, even though 10-year bond yields have risen, quashing the bubble theory, in his view. In the last one year, NASDAQ has zoomed 69%, while Dow Jones and S&P 500 have surged in the range of 40-45%.
Equity risk premium attractive
Currently, the equity risk premium or the stock earnings yield relative to bond yields is at a positive 2.9%. For context, the same stood at a negative 2% during the technology bubble in the late 1990s and early 2000s. “So, clearly, at a plus 2.9%, we are still lightyears away from that, which was a real bubble,” Brett Nelson said.
Although recently, the 10-year yields have soared, Nelson and his team do not believe that the yield has surged enough to warrant a struggle for Wall Street. He added that since the Second World War, the nominal US GDP growth has been 5% while inflation has been at 2%. “And so, when the ten-year bond yield got above 5%, that’s when you really started to see stocks struggle,” he said. Based on the same theory, only when 10-year yields cross the 3.5% mark, Nelson believes markets would start to struggle.
Economic expansion to aid stock markets
Further, Nelson said that the rebounding US economy is a good enough reason why he is advising clients to hold their position. Economic expansions have been good for stocks and the cycle of expansion lasts longer than just a year. “We have seen over past economic expansions in the post World War 2 period the average trough to peak gain for equities during those expansions is around 200%. So, even though we have had a rally of about 80% in the S&P 500 from last year’s low, there is still ample scope for further gains based on the historical precedent.”
Time for value stock shopping
Going ahead, the growth era could now be turning a page and it might be time for value stocks to shine, in Brett Nelson’s view. He said that cyclical stocks in the energy sector, financial space, and industrials could surprise on the upside after having lagged behind during the peak of the coronavirus pandemic.