Portfolio Strategy: Why equities should
outperform bonds; report published
Analyst Comment
We examine current relative valuations, compare them with the past and look
at key
future drivers. We conclude that equities now offer superior prospective
relative returns,
although absolute returns on both assets are likely to be low; wide
variation by country is
expected. Report published.
Full details
Valuation stretched We look at a number of relative valuation measures such
as earnings yield ratios and dividend yield ratios adjusted for inflation.
These make equities look cheap
relative to bonds. We find that equities still show a valuation advantage
despite their recent rally, even after we have incorporated risk into the
relative valuations.
The disappearing risk premium We find that from 1900 the excess return of
equities to bonds has been about 5% p.a. However, given the magnitude of
recent price collapses, the
excess return on equities relative to bonds between 1960 and today has been
just 3% p.a. Buying equities and bonds at the start of the great bull market
in 1980 would have resulted
in a zero risk premium. This is too low. The probability of equities
outperforming bonds by more than 4% p.a. is around 60% after holding both
assets for five years. However, if bought when the relative performance of
equities has fallen below the long run trend (such as now) the probability
rises to about 75%.
Unusual relationships A significant negative correlation between equities
and bonds has been rare over the past 130 years. Such a relationship occurs
typically during periods of
intense uncertainty and/or deflation. The current negative correlation is
unlikely to continue in our view. Overweight equities vs bonds Our DDM
models suggest that equity markets are currently
10% undervalued.
Our GSWIRE bond valuation models now point to bond markets being up to 20%
overvalued. However, exogenous factors such as asset allocation shifts and
deflation risk may prevent fair values from being restored immediately in
both asset classes. We expect equity and bond returns in Europe to be low in
the future but with equities achieving excess return of between 3% and 4%.
Within bonds, we favour corporate to government.
I, Peter Oppenheimer, hereby certify that all of the views expressed in this
report accurately reflect my personal views about the subject company or
companies and its or
their securities. I also certify that no part of my compensation was, is, or
will be, directly or indirectly, related to the specific recommendations or
views expressed in this report.
Gruß Pichel 
