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The New Equity Risk Premium
Event
We update out US equity risk premium forecasts after S&P‟s downgrade of
America‟s credit rating to „AA+‟. We believe US bonds are still one of the least
risky assets and that it is appropriate to use US treasury bonds as a proxy for
the theoretical “risk free” rate in our equity risk premium estimates.
Impact
The US equity risk premium (ERP) was 1 standard deviation above the longterm
average at the end of July and by mid-August this had already blown out to
nearly 2 standard deviations on worries over US growth and the spread of the
European debt crisis to Spain and Italy. The dramatic rise in the equity risk
premium was two-thirds due to the fall in US equities and one-third due to the
fall in 10-year bond yields. We have achieved a “new” and important threshold.
The last time the ERP rose to similar levels was when Lehman collapsed in
September 2008, with the ERP later peaking at 7.6% in December 2008. In
that case, the normalisation of the ERP began with a roughly 100-bp rise in
bond yields, while equities continued to fall until March 2009. We thus expect
a strong bounce in bond yields before an equity market rebound occurs.
At an ERP of almost 6.5% we expect growth style to outperform value over
the next 12 months. This is because stocks with earnings certainty often
outperform in a weakening environment, despite their higher PERs.
Outlook
Compared to bonds, equity markets look cheap on forward earnings
estimates. For investors with a long-term outlook, equities can be
purchased. But earnings risk, coupled with the escalating European
sovereign debt crisis and seasonal risk that is yet to peak, suggests our
defensive approach continues for those with a short-to-medium term
outlook. This means a preference for bonds over equities, developed over
emerging markets, large caps over small caps and defensive sectors over
cyclical sectors.
For buy ideas, the table on the left highlights four defensive stocks drawn from
the Macquarie Marquee lists globally. We also include three telecom stocks
with attractive dividend yields as their earnings streams are increasingly
attractive in a falling interest rate environment.
Given equities are cheap, we continue to expect a rebound later in the
year. The critical question is when to take a more aggressive approach,
and we believe it’s prudent to wait for a signal from the bond market.
Specifically, based on the 2008/09 experience, we would expect bond yields
to rally by 50-to-100bp before a rally in equity markets occurs. Looking
forward, we expect the next signal on US rates to come from the Jackson
Hole meeting of the Fed later this month. If there is talk of the need for further
stimulus, such as another asset buying program, this would be bullish for both
equities and commodities.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
The New Equity Risk Premium
Event
We update out US equity risk premium forecasts after S&P‟s downgrade of
America‟s credit rating to „AA+‟. We believe US bonds are still one of the least
risky assets and that it is appropriate to use US treasury bonds as a proxy for
the theoretical “risk free” rate in our equity risk premium estimates.
Impact
The US equity risk premium (ERP) was 1 standard deviation above the longterm
average at the end of July and by mid-August this had already blown out to
nearly 2 standard deviations on worries over US growth and the spread of the
European debt crisis to Spain and Italy. The dramatic rise in the equity risk
premium was two-thirds due to the fall in US equities and one-third due to the
fall in 10-year bond yields. We have achieved a “new” and important threshold.
The last time the ERP rose to similar levels was when Lehman collapsed in
September 2008, with the ERP later peaking at 7.6% in December 2008. In
that case, the normalisation of the ERP began with a roughly 100-bp rise in
bond yields, while equities continued to fall until March 2009. We thus expect
a strong bounce in bond yields before an equity market rebound occurs.
At an ERP of almost 6.5% we expect growth style to outperform value over
the next 12 months. This is because stocks with earnings certainty often
outperform in a weakening environment, despite their higher PERs.
Outlook
Compared to bonds, equity markets look cheap on forward earnings
estimates. For investors with a long-term outlook, equities can be
purchased. But earnings risk, coupled with the escalating European
sovereign debt crisis and seasonal risk that is yet to peak, suggests our
defensive approach continues for those with a short-to-medium term
outlook. This means a preference for bonds over equities, developed over
emerging markets, large caps over small caps and defensive sectors over
cyclical sectors.
For buy ideas, the table on the left highlights four defensive stocks drawn from
the Macquarie Marquee lists globally. We also include three telecom stocks
with attractive dividend yields as their earnings streams are increasingly
attractive in a falling interest rate environment.
Given equities are cheap, we continue to expect a rebound later in the
year. The critical question is when to take a more aggressive approach,
and we believe it’s prudent to wait for a signal from the bond market.
Specifically, based on the 2008/09 experience, we would expect bond yields
to rally by 50-to-100bp before a rally in equity markets occurs. Looking
forward, we expect the next signal on US rates to come from the Jackson
Hole meeting of the Fed later this month. If there is talk of the need for further
stimulus, such as another asset buying program, this would be bullish for both
equities and commodities.
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