Tags: equity | risk | premium | Fed

NY Fed: Bull Market to Last 5 More Years

By Michael Kling   |   Thursday, 16 May 2013 07:56 AM

How long will the latest bull market last? Another five years, according to New York Federal Reserve economists.

Most central bank economic models predict that we will enjoy "historically high excess returns for the S&P 500 for the next five years," write New York Fed economists Fernando Duarte and Carlo Rosa in a new report.

Super-low Treasury yields are the main basis for a long-term bull market, they conclude.

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The pair analyzed 29 of the most popular models used to compute the equity risk premium, or the expected future return of stocks minus the risk-free rate. They include surveys, dividend-discount models, cross-sectional regressions and time-series regressions, which together use more than 30 different variables, ranging from price-dividend ratios to inflation.

The models show equity risk premium is now high and predict it will remain high for five years. As of December, the equity risk premium was 5.4 percent. By comparison, the average equity risk premium is approximately 3 percent.

The premium is likely high at all investment horizons because Treasury yields are exceptionally low at all foreseeable time horizons, the researchers concluded.

High dividends are also a possible reason, but current dividends are near their historical average and future dividends are expected to grow only modestly above average in coming years.

"[E]xceptionally low yields are more than enough to justify a risk premium that is highly elevated by historical standards."

Most models, they say, also predict good returns.

Low Treasury yields — driven by the Federal Reserve buying large quantities of bonds — are boosting the stock market to new heights. Yet experts disagree on what will happen if yields rise when the Fed winds down its bond-buying program.

Although some experts predict stocks will drop when the Fed lets yields rise, David Tepper, founder and president of Appaloosa Management, says stocks will continue to thrive as the Fed shrinks its quantitative easing.

"The economy is getting better, autos are better, housing's better it continues to improve," the hedge fund manager told CNBC. "They can't find enough people to work in housing, that's the only thing holding it back right now."

Stocks are still cheap, he said.

"When the equity risk premium is high historically, you get better returns after that."

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