A lift in the equity risk premium (ERP) represents a cohesive narrative of a number of key empirical phenomena in financial markets: stock markets have not-rated despite the drop in the risk free rate, animal spirits in the corporate sector remain dormant despite high profit shares globally and stocks offering earnings certainty are trading on stretched multiples. The higher ERP probably reflects a rise in the risk premia that households are assigning to their stream of expected future net cash flows, which has led to a substantial drop in the stock of human capital. This is fertile ground for those looking to understand the sources of timing of a reversal of the rising ERP which will lead to a tectonic shift in the relative performance of 'safe' assets: low beta stocks, low volatility stocks, high grade corporate bonds and sovereign bonds. The dangers of safety will re-emerge, but not just yet. (VIEW LINK)
Founder of Evidente, Salvatore Ferraro, is a top rated quantitative analyst and has over 17 years of experience in financial markets, with investment banks, Goldman Sachs and Merrill Lynch, providing advice on best practice to portfolio managers...
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