Do Equities Perform Better When Bond Yields are Lower?

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Decades of research has documented the existence of a positive realized equity risk premium (ERP), i.e., that stocks have outperformed bonds over the long-term. But there is less research on the relative future performance of stocks in international markets during different bond yield environments (i.e., the expected ERP). This article summarizes some of my forthcoming research in the Journal of Investing where I explore this effect using the Jordà-Schularick-Taylor (JST) Macrohistory database, which includes historical returns from 16 countries from 1870 to 2015.

While future equity returns have generally been lower during periods of lower bond yields, the decline is less than would be implied by a constant expected ERP. The predictive significance of bond yields varies significantly depending on the future return metric considered (nominal return versus real return, as well as total return versus price return), and whether dividend yields and inflation are considered. Overall, while the data is noisy, the analysis strongly suggests assumed returns for stocks should vary with bond yields and this should be reflected in financial projections.