The case for owning bonds over stocks is at its strongest since the 2000s, according to the equity risk premium!
The equity risk premium measures the additional return an investor can expect to earn for investing in the stock market over a risk-free 10-year US government bond.
In the US, the premium has fallen to its lowest level since the 2000s, which could be seen as a red flag for equity investors.
The chart below has been put together using Bloomberg data. It shows the S&P 500 earnings yield less the 10-year US government bond. Generally, stocks require a higher additional return to compensate investors relative to bonds because they offer similar returns for less risk.
*Source: Bloomberg
As a result, many investors are recalibrating how big a role stocks play in their portfolios. Rising bond yields raise the cost of capital for companies, threatening their balance sheets. At the same time, companies projected future cashflows are more heavily discounted in analysts’ models when bond yields rise, as investors can now get a higher reward from risk-free government debt.
The current equity risk premium is only 0.06. That is a long way from the highs of 2008 when it was close to 8%.
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