Listen, it’s all about “relative” attractiveness these days when it comes to assessing opportunities at the asset class level.
It’s kind of like being at the bar for last call and all the actually attractive women left a long time ago and you have to kind of make a decision based on what the market is giving you which, at say, 3 a.m., isn’t much.
Or like when you’ve just finished a great dinner in Mid-Town and six hours later you’re at the strip club with your boss. You know all the bars are closing down so it’s either spend the rest of that $975 he gave you on a private show with the stripper or call it a night and catch an Uber back to your apartment.
The point is, stocks are rich, credit is rich, govies get you nothing, etc. etc. So nothing is truly “attractive.” Things are only “relatively” attractive.
Well with that as the context, consider the following interesting bit from Goldman who notes that if you’re looking for a reason to prefer equities over bonds in your portfolio allocation, you might consider that for more than a quarter century, you’ve gotten equity-like returns from bonds and you know, how much f*cking longer do you expect that to last?
Alongside falling bond yields, credit also racked up huge returns. These markets were supported by strong balance sheets but the insatiable search for yield in a near zero rate world was also crucial.
The unusual combination of high asset returns enjoyed through most of the past seven years can be seen in Exhibit 4 – as a result multi-asset returns have been strong. Exhibit 4 maps the annualised real returns for US bonds and equities over 10 year holding periods; for each year on the x axis the bar shows the real rolling return over the next 10 years.
There are three interesting observations here:
- Over recent years, the 10 year holding return has been high by historical standards in both asset classes.
- The real return on bonds over 10 year rolling holding periods has averaged a staggering 5.2% for the past 40 years; this is in line with the very long run real returns in equities! In other words bond holders have enjoyed equity-like returns for over a quarter of a century but with a much lower risk and volatility profile.
- The ex post equity risk premium (Exhibit 5) is still below average following one of the most negative periods during the financial crisis that has been experienced since WWII.
The rebound in the equity risk premium was part of our Long Good Buy thesis in 2012. The ex post risk premium had fallen to record lows and the implied equity risk premium had increased to record highs! – the signal this gave for equity investors was very powerful. We argued that ‘the prospects for future returns in equities relative to bonds are as good as they have been in a generation’. Over recent years the picture has started to normalise but, in our view, it has further to go; equities continue to offer better prospective returns than bonds on a 12-month plus holding period. As Exhibit 6 shows, from current levels of bond yields, only modest rises in yields would offset coupon payments and deliver negative returns, so there remains good prospects of still better returns in equities than bonds on a forward looking basis. The problem is knowing how much of this ‘normalisation’ of the equity risk premium comes from equities going up, bond prices going down, or a combination of the two.