Aug

30

I am reading a book on equity risk premiums and it provided a nice frame work to view bonds and stocks. The equity risk premium P is fairly stable over time, meaning the excess required return to hold the riskier* asset of stocks over bonds. So when bonds go down, for example, as they are now, riskless rates are going up. This means the required return for stocks = riskless rates plus P, in now also higher. So either the future prospects for stock earnings must be better, or stocks must go down now to make up the difference. That seems to be the battle we will be in for the post Bernanke world. One eye on earnings, the other on bonds.

*Note the last few years has proved there really is no such thing as a riskless rate, real rates can stay negative for a long time, and sometimes in bond risk is higher than equity risk. But all that hurts my brain too much to contemplate.


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