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Morning Notes — Equity Risk Premium

Equity Risk Premium

July 9, 2020

Virus: I know the headlines read differently, but new case and hospitalization data in AL, CA, FL, NV, SC and TX are showing early signs of peaking momentum. If the outbreaks in these states follow curve dynamics present elsewhere, case counts should begin to decelerate within a week or two.

Preview: CQ2 earnings season kicks off next Tuesday morning with three large cap banks reporting. I previewed the banks yesterday, but want to reiterate the likelihood for Q2’20 to mark a trough (possibly a clearing event) in bank fundamentals. Keep a close eye on the banks as the performance of Financials tends to lead most pro-value trades. And Tuesday, I covered low expectations for Q2 earnings in general but want to add that the unofficial preannouncement season has thus far included the following positive preannouncements: AA, CRTO, Electrolux, FCX, HIMX, MXL, Pandora A/S, PTC, QDEL, SAP, SBH, TMHC and TMO.

SPX: Positioning indicators suggest many investors didn’t participate in the rally off the March lows. Light equity positioning was initially based on reduced earnings forecasts based on lockdowns and a valuation framework based on ~3% ten-year bond yields. Of course, ten year yields are now ~0.60%, which makes for a far-higher equity risk premium/much higher multiple. Relative to bond yields, the S&P 500 is extremely inexpensive and the largest pools of investment look across the different asset classes for relative value. You can back into the equity risk premium calculation using a two-stage, ten-year dividend discount model to conservatively (giving no credit for the impact of the current liquidity boom) reach a ~9% expected return for equities. And bonds yield ~0.60%.

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