The “equity risk premium”—the extra profit investors collect for owning stocks instead of bonds—has shrunk to 1.59 percentage points, its smallest since October 2007, The Wall Street Journal reported.
Bonds tend to be safer than stocks, but equities offer the prospect of higher returns. If they did not, investors would tend to gravitate toward bonds’ promise of safety and the stock market would have fewer players.
Since 2008, the premium has averaged about 3.5 percentage points.
However, now the premium has been weighed down by rising interest rates’ toll on share prices and corporate earnings. Ironically, those same rising interest rates have made bonds a greater draw for yield-seeking investors.
Also, the banking industry is shaky after recent, high-profile bank failures; the commercial real estate market is crumbling; and the world’s economic outlook continues to be gloomy. All of those factors make stocks less attractive.
In addition, U.S. stocks are pricier than those anywhere else in the world. The current price-to-earnings ratio is around 29, higher than it has been 90 percent of the time since 1881, the WSJ said.
Corporate earnings should tick up about 1.6 percent this year, according to data service FactSet. At the beginning of this year, those same analysts foresaw a 5-percent jump.
The Standard & Poor’s 500 stock index lost roughly 20 percent last year but had regained about 6.9 percent this year as of 8 April.
At the same time, the Bloomberg U.S. Aggregate Bond Index is up 4.2 percent this year, not far behind stocks’ performance and promising fewer sleepless nights.
Bonds are now “a once-in-a-generation opportunity,” Tony DeSpirito, BlackRock’s chief U.S. equities investor, told the WSJ.
Also, although the equity risk premium has fallen to its smallest since 2007, it remains close to the 1.62-percentage-point average that has prevailed since 1957, he noted, adding that stocks still are likely to outperform bonds in the weeks and months ahead.
TREND FORECAST: Again, where the markets are going and why is a guess on The Street. Troy Gayeski, the chief market strategist at FS Investments, told Bloomberg that the S&P 500 will likely fall 22 percent in the next few quarters. “This is a golden opportunity to use this bear market rally to de-risk in advance of potentially very painful losses over the next six, nine, 12 months,” he said.
We have noted that following the last 40 mid-term elections in the United States, the S&P 500 increased more than 16 percent over the following 12 months. However, as we forecast, should the Feds raise interest rates 25 basis points in May, equities and the economy will decline.