Fed Economists Say Low Rates May Boost Stocks for YearsJeff Kearns
U.S. stock investors may reap unusually high returns during the next five years thanks to record-low interest rates on government bonds, according to researchers at the Federal Reserve Bank of New York.
A survey of 29 models for the equity risk premium -- the expected future return of stocks over the risk-free rate offered by Treasuries -- shows “we will enjoy historically high excess returns for the S&P 500 for the next five years,” Fed economists Fernando Duarte and Carlo Rosa said in a paper released today, referring to the Standard & Poor’s 500 Index. The premium rose to a record 5.4 percent in December, they said.
“The equity risk premium is high mainly due to exceptionally low Treasury yields at all foreseeable horizons,” they said.
Equities are near the cheapest level ever compared to government debt even after the S&P 500 surged 14 percent this year, according to the so-called Fed Model, which compares the earnings yield for stocks with Treasury rates. The valuation measure was derived from a July 1997 report from the central bank.
Per-share profit of $102.45 for all S&P 500 companies represents 6.3 percent of the index’s price level, or 4.53 percentage points more than yields on 10-year Treasury notes, according to Fed Model data compiled by Bloomberg.
The S&P 500 rose 0.4 percent to 1,631.64 as of 3:42 p.m. in New York as eight of 10 industry groups advanced. The yield on the 10-year Treasury note was little changed from yesterday at 1.77 percent.
The Fed researchers surveyed banks, academic papers and economists at central banks to find the most “popular and widely used models” for calculating equity risk premium over the last 50 years. They analyzed surveys, models and regressions which together use as predictors more than 30 variables, ranging from price-dividend ratios to inflation, according to their report.
The S&P 500 rose to its fourth straight record yesterday, while the Dow Jones Industrial Average closed above 15,000 for the first time on optimism over global central bank stimulus and better-than-estimated corporate earnings.
Stocks are in the fifth year of a bull market amid three rounds of bond purchases by the Fed aimed at bringing down interest rates, spurring economic growth and reducing unemployment. The so-called quantitative easing has pumped up the central bank’s balance sheet to $3.32 trillion.