Ozempic comes for the ERP

Risk premia are getting thin, again.
David Berthon-Jones

Aequitas Investment Partners

There are a lot of different ways to calculate equity risk premia (ERP). Our graph below looks at a few of these.

You can take a measure like the S&P 500 forecast earnings yield, and subtract the risk-free rate, say, the US 10yr treasury bond rate. You can go a step better by using real risk-free rates, using either TIPS (Treasury Inflation Protected Securities) or using a measure of expected inflation from the SPF (Survey of Professional Forecasters). 

You can attempt to calculate the equity risk premia by wedging a proxy for the long-run rate of real earnings growth, to get a more complete measure (e.g. an ERP with growth estimates included, wg, or excluding it, xg). 

And, in our view, you can normalise for the business cycle, by using a Shiller CAPE earnings yield (Cyclically Adjusted Price-Earnings ratio).

That's how the graph below comes together. What does it tell us?

Different flavors of the equity risk premia. 

Well, we can note that ERP's got very skinny in 1999, just prior to the tech wreck. We can note it averaged a little over 5% in the years after the huge market sell-off,  and that as a "line in the sand" it's been a reasonably useful guide to over or undervaluation. 

However, on current numbers, however, you choose to dice it, that ERP is not very large. There is a degree of increasing euphoria, as the market believes that good growth continues, AI benefits a handful of listed firms, unemployment stays low and inflation recedes. 

That may all well still happen, but, are you fairly compensated for the risk it doesn't?

That's a question investors need to be asking themselves. 


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This document has been prepared by Aequitas Investment Partners ABN 92 644 165 266 (“Aequitas”, “our”, “we”), a Corporate Authorised Representative (no. 1284389) of C2 Financial Services, (Australian Financial Services Licensee no. 502171), and is for distribution within Australia to wholesale clients and financial advisers only. This document is based on information available at the time of publishing, information which we believe is correct and any opinions, conclusions or forecasts are reasonably held or made as at the time of its compilation, but no warranty is made as to its accuracy, reliability or completeness. To the extent permitted by law, neither Aequitas nor any of its affiliates accept liability to any person for loss or damage arising from the use of the information herein. Please note that past performance is not a reliable indicator of future performance. General Advice Warning: This document has been prepared without taking into account your objectives, financial situation or needs, and therefore you should consider its appropriateness, having regard to your objectives, financial situation and needs. Before making any decision about whether to acquire a financial product, you should obtain and read the relevant Product Disclosure Statement (PDS) or Investor Directed Portfolio Service Guide (IDPS Guide) and consider talking to a financial adviser. Taxation warning: Any taxation considerations are general and based on present taxation laws and may be subject to change. Aequitas is not a registered tax (financial) adviser under the Tax Agent Services Act 2009 and investors should seek tax advice from a registered tax agent or a registered tax (financial) adviser if they intend to rely on this information to satisfy the liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law.

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David Berthon-Jones
Co-Chief Investment Officer
Aequitas Investment Partners

David is Co-CIO of Aequitas Investment Partners with Dr Rowan Stewart. David and Rowan are responsible for investment strategy and the delivery of reliable, cost-effective multi-asset, and direct equity portfolio solutions to Advisers, Dealer...

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