At 5.7%, the AlphaValue equity risk premium at the close of 2020 is the lowest of the last 20 years. This is the reflection of a lot of central bank money chasing risk assets. Previous major occurrences of extra low ERP happened in early 2007 when nobody was willing to read their newspaper about the US subprime crash collateral effects, and early 2017 on the verge of what developed as the only successful year of the last 15 years in terms of earnings growth.
The 2021 opening at 5.7% is astounding as markets will pay for a recovery that was below par only one month ago and now looks unlikely to happen as wave 3 of the pandemic is leading forecasters to cut anew on their GDP growth expectations. The World Bank made ugly noises on 05/01/2021. It is unlikely to be alone.
The odds are for 2021 earnings growth hopes (now +45% after -38% in 2020) to be trimmed rapidly. If prices do not adjust in parallel, the equity risk premium will continue to fall and obviously suggest that a crash is overdone. Like the Bitcoin or Tesla share price, equities’ multiples (2021 P/E at 18.7x or 19.7x ex Banks) are disjointed from daily realities in a ‘pass the hot potato parcel’ exercise.
This amazing dash for risk is confirmed by the AlphaValue price momentum metrics where stocks with a strong share price momentum (green line below) are edging close to accounting for 70% of the universe. This is a massive proportion that usually does not last.
It is hard to fight against a central bank, goes the saying. But it may pay to be cautious. Consider flying with BAE rather than throw more money at, say, Adyen (94x 2022 earnings incidentally).
More on AlphaValue’s Equity Risk Premium : click here