UBS delivers a poke in the eye for equity bulls
The bull markets are raging, IPOs are surging and investors are pinning their hopes on the FTSE breaking through the 7,000 barrier for the first time this year.
All is rosy in the world of equities – unless you happen to pay attention to something called the equity risk premium.
This is the difference between the return you get from stocks and the return you get from bonds.
A new research note from investment bank UBS shows it’s falling, which has big implications for where investors put their cash.
As the chart below shows the premium you get from buying stocks over bonds is back at its normal long term level over a decade long period (the chart on the right)
The chart on the left shows its longer term average, which shows the premium is still elevated.
“What used to be a ‘screaming buy,’ is now a less compelling proposition,” the bank’s analysts say.
The situation is even more acute in the UK. As this table shows, the UK’s equity risk premium was the highest of all the developed economies in mid-2011 but it has declined considerably.
Investors have swivelled dramatically by shifting assets out of bonds into equities in recent years, to take advantage of the premium.
The fact the premium has declined to a more normal level is likely to entail a flow of capital out of equities – which could perhaps leave markets a little less rosy in future.