Over the past decade, stocks have significantly outperformed bonds, and the equity risk premium (ERP) has fallen to its lowest level since the late 1990s. The implied ERP in the US is approximately 2.6%, meaning the extra return compensation from stocks relative to bonds has thinned. As long-term Treasury yields rise, bonds are becoming more attractive again, making stocks more sensitive to rising interest rates. However, at this stage, the speed of the rise in bond yields is more crucial than the amount. Goldman Sachs believes that the space for the stock market to continue relying on valuation expansion is limited, and corporate earnings growth will become a more critical factor determining stock returns. (Goldman Sachs report, September 17)
Note: The "equity risk premium" can be understood as how much higher the stock return is compared to the bond return. The lower this number, the less "cheap" stocks are relative to bonds.
