Why Equities Are Cheap: Another Goldman Sachs Insider Tip

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You will recall the insider trading scandal involving Rajat Gupta, Board Member of Goldman Sachs, who disclosed confidential information following a Board meeting.

Well I had lunch last week with Jim O’Neill, Chairman of Goldman Sachs Asset Management. Let me share not so confidential information from an intimate lunch at which Jim kindly served me drinks (I have peaked!).

One of the most conservative measures of equity valuations is the equity risk premium (ERP). This is how it works and why equities are cheap – as described to me by Jim.

We assume real earnings growth is the same as real GDP growth trend. In the UK that is 2.3%. We then add dividend yield (3.5%). That then gives the expected real return. If we subtract the real bond yield (-1.2%) then we get the implied ERP. In the case of the UK that is 7%. That is how much more you are effectively getting for owning equities over bonds. That’s a pretty good reason to own equities.

Check on ADVFN’s charting and you will see just how the FTSE 100 is not only off its all time high, but compared to the US’s proximity to its all time high the FTSE should be closer to it’s all time high.

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