Stocks have 'rarely been as attractive relative to bonds,' says Goldman

Published Thu, Aug 27 20202:18 PM EDT

(This story is for CNBC PRO subscribers only.) Global equities have "rarely been as attractive relative to bonds," according to new research from Goldman Sachs, and investors should rotate into stocks since they'll "likely outperform bonds" over the next twelve months. The firm's analysis is based on the equity risk premium, which is currently close to an all-time high. The call comes despite growing concerns that current valuations are stretched. Global stocks have retraced 99% of their coronavirus losses, and Goldman noted that equities are the most expensive they've been since the tech bubble based on the price-to-earnings ratio over the next 24 months. While European equities might continue to outperform beyond the next 12 months, Goldman believes that at that point investors should downgrade their exposure to U.S. stocks. Stocks are riskier than bonds, meaning that investors expect a certain amount of additional upside when choosing to buy equities rather than "risk-free" assets like government bonds. The equity risk premium captures that additional rate of return that investors expect. "The essence of the ERP is to guide investors in their equity/bond allocation, and we find that variations in the ERP do indeed tend to be a good asset allocation signal: a rise in the ERP often coincides with higher excess returns on equities relative to bonds in the subsequent year," Goldman wrote. Calculating the equity risk premium isn't set in stone and a number of different metrics can be used in the analysis. Goldman's "market-implied ERP" is based on a dividend discount model, while the "macro-implied ERP" is based on factors like GDP growth and debt levels. "At 4.6% in the US and 6.7% in Europe, the current market-implied ERP ... suggests that equities should offer positive returns relative to bonds throughout the next 12 months," the firm's strategists led by Lilia Peytavin wrote in a note to clients Thursday. "In one year's time, while European equities should continue to deliver excess returns over bonds, our model suggests US equities should offer fairly similar returns to those for bonds, albeit modestly positive." The firm's analysis suggests that the STOXX Europe 600 could rise another 10% by 2021, with a more modest 3% gain for U.S. equities. When choosing how to allocate a portfolio each investment is considered relative to other options in the market. So a high ERP doesn't necessarily mean that equities are about to surge higher. Rather, it means that stocks are poised to provide better returns than bonds. As Goldman noted, "the ERP is currently close to all-time highs mainly because bond yields have fallen to an all-time low." "The US stock market will likely recover faster than the European one, and bond yields could rise later in Europe. This is in line with our asset allocation, which is modestly pro-cyclical and is OW on equities over bonds on a 12-month horizon," Goldman added. - CNBC's Michael Bloom contributed reporting.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., March 20, 2020.

Lucas Jackson | Reuters

(This story is for CNBC PRO subscribers only.)

Global equities have "rarely been as attractive relative to bonds," according to new research from Goldman Sachs, and investors should rotate into stocks since they'll "likely outperform bonds" over the next twelve months.

The firm's analysis is based on the equity risk premium, which is currently close to an all-time high.

The call comes despite growing concerns that current valuations are stretched. Global stocks have retraced 99% of their coronavirus losses, and Goldman noted that equities are the most expensive they've been since the tech bubble based on the price-to-earnings ratio over the next 24 months.