Even as the S&P 500 index soared to all-time highs on Monday, analysts at Société Générale say stocks still look attractive by this one measure.
The sharp decline in government bond yields this year has lifted the so-called equity risk premium, or the excess return for equities over a risk-free rate of return such as U.S Treasury debt. When the premium stands above historical highs, stocks show better value than bonds, and vice versa.
Based on this premium, equities still look like a good bet even as stock-market gauges hit or hover near all-time records, said Praveen Singh, a strategist on the global asset allocation for Société Générale, in a research note on Monday.
He calculated that the current U.S. equity risk premium stood at 5.3%, well above its long-term average of 3.9%.
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“Current level of bond yields is relatively low and equity risk premium relatively high. So even if there is some rise in bond yields, equities can absorb higher bond yields,” Singh said.
The S&P 500 SPX, +0.12% carved out a fresh record and intraday close on Monday, and was last seen trading flat at 3,040. The Nasdaq Composite COMP, -0.27% and Dow Jones Industrial Average DJIA, +0.13% were also both less than 1% away from their own all-time finishes as of Oct. 28, according to Dow Jones Market Data.
Even as stock prices have shot higher, government debt yields have steadily declined. The 10-year Treasury note yield TMUBMUSD10Y, +0.19% stood at 1.830% on Tuesday, down around 86 basis points from 2.691% at the end of 2018, Tradeweb data show.
Singh, however, says it’s important not to look at the equity risk premium in isolation, as it only signals the relative attractiveness of stocks over bonds.
If investors looked at other valuation measures such as the cost of equity, which tracks expectations for long-term returns, U.S. equities remained expensive.
“This essentially indicates that investors expect the U.S. equity market to deliver lower returns but a return on the equity market likely higher than that on government bonds,” he said.
Analysts at Société Générale has stayed bearish on U.S. stocks, citing expectations for a 2020 recession and stagnating earnings growth.
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