Even allowing for strong near-term earnings growth, the excess return for equities over bonds priced into markets has recently dropped sharply: higher bond yields set a higher bar (slides 6-17)
- Over 155 years of history, US equities have outperformed bonds by 4.8% a year
- But starting point matters: outcomes on a 10-year horizon varies substantially
- Relative valuations matter: equities outperform bonds by more when their “earnings yield” is high vs bond yields
- “Yield gap” is low right now, a negative signal about equities’ relative prospects over the medium to long term
- But there are 10yr periods when this metric is low yet equities still did well. What was behind these “surprises”?
- usually strong real EPS growth, valuations often declined
- Valuation metrics are still high but trailing and forward P/Es have partially de-rated, thanks to strong earnings trends (slides 35-37). Consensus earnings growth expectations are high
- This helps the equity return outlook but the recent rise in bond yields helps the bond return outlook by more
- Equities expected outperformance over bonds has declined
- Analyst coverage is lower outside the US, in EM vs DM, in small caps vs large caps, and the further out to the future you look – the active management opportunity is greater where coverage is lower
- Consensus “long-term” forecasts are from too small a sample to be credible
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