Stocks have rarely been this expensive versus bonds. Now, UBS expects that to change.

MW Stocks have rarely been this expensive versus bonds. Now, UBS expects that to change.

By Steve Goldstein

Profits to GDP ratio may not be sustainable, strategists say

Welcome to the lion's den of what could be called event risk: mega-cap earnings, huge economic reports, Treasury refunding, with this minor election thingy too. Buckle up.

This barrage of headlines is set against what's been a powerful bull market. The equity risk premium, the excess return that investors demand from stocks over the risk-free rate, is at the 15th percentile of a 100-year distribution - meaning stocks have rarely been more expensive.

UBS strategists led by Nicolas le Roux say that's about to change.

"As we enter an era of deglobalization, limited policy room and higher geopolitical risks leading to higher macro volatility, we expect ERP to climb higher, i.e. for equities to cheapen relative to bonds," they say in a new 75-page report delving into the topic.

One way the ERP could change is by bonds getting more expensive. Using the HOLT valuation model, they say inflation-adjusted bond yields should be 150 basis points lower - so around 0.5% instead of 2%.

They also note that corporate profits relative to GDP is in the 95th percentile right now of a 75-year distribution. "This is another way of saying that profits may not be sustainable as a ratio to GDP and that ERP has to rise again," they say. They add that they expect the downward trend in corporate tax rates to end.

A model they use to forecast five-year returns using the equity risk premium suggests pretty solid gains for the U.S. - some 6.1% per year. UBS says that's because of a high base effect with investors appreciating the historical ability of U.S. companies to grow earnings. But the UBS team say if inflation-adjusted rates rise to what's priced into the forwards market - the expected returns would fall to 3.7% per year.

They also use the framework to identify potential value trades. They say U.S. growth names with potential appreciation include Moderna $(MRNA)$, Pinterest $(PINS)$, Celsius Holdings $(CELH)$, DraftKings $(DKNG)$, Paycom Software $(PAYC)$, Okta $(OKTA)$ and Neurocrine Biosciences $(NBIX)$, while European and emerging market growth names that could see potential price depreciation include Verbund (AT:VER), Legrand (FR:LR), Banco Santander Chile and Colgate-Palmolive India (IN:500830).

The market

U.S. stock index futures (ES00) (NQ00) were steady to higher early Wednesday after upbeat Alphabet results. Gold (GC00) continued to march higher, trading just below $2,800 an ounce. Treasury yields BX:TMUBMUSD10Y eased.

   Key asset performance                                                Last       5d      1m      YTD     1y 
   S&P 500                                                              5832.92    -0.31%  2.18%   22.29%  39.08% 
   Nasdaq Composite                                                     18,712.75  0.75%   4.48%   24.66%  45.61% 
   10-year Treasury                                                     4.219      -2.40   43.10   33.81   -51.51 
   Gold                                                                 2796.6     2.47%   4.34%   34.98%  40.44% 
   Oil                                                                  67.59      -4.86%  -4.82%  -5.24%  -16.45% 
   Data: MarketWatch. Treasury yields change expressed in basis points 

The buzz

Alphabet stock $(GOOGL)$ rallied as the Google owner reported surprisingly strong cloud revenue.

Magnificent Seven peers Meta Platforms $(META)$ and Microsoft $(MSFT)$ report after the close.

Advanced Micro Devices $(AMD)$ shares meanwhile slumped as the chipmaker's results largely met analyst expectations and its guidance came in a bit short of expectations.

Meme-stock investor Keith Gill disclosed he's sold the entirety of his stake in Chewy $(CHWY)$.

U.S. third-quarter GDP is set for release, as is ADP's estimate of private-sector payrolls, pending-home sales, and the Treasury's quarterly refunding announcement.

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The chart

According to Jeffrey Hirsch, editor in chief at the Stock Trader's Almanac, the best-six month period of the year starts right now. The S&P 500 averages 7.1% between November and April and has advanced 77% of the time since 1950. The Dow is slightly stronger, up 7.4% and gaining 77% of the time.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

   Ticker  Security name 
   GME     GameStop 
   NVDA    Nvidia 
   TSLA    Tesla 
   DJT     Trump Media & Technology 
   AMD     Advanced Micro Devices 
   GOOGL   Alphabet 
   META    Meta Platforms 
   AMZN    Amazon.com 
   MSFT    Microsoft 
   AAPL    Apple 

Random reads

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-Steve Goldstein

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October 30, 2024 06:43 ET (10:43 GMT)

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