The concept of Equity risk premium is an important one that helps decision makers in how to allocate money between equities and fixed income. In its simplest form, is the difference between the expected return in Equities minus the risk free rate. We can debate whether we can calculate the expected return and what is the risk free rate these days, but the idea is to have a measure of how well an investor is compensated for the extra risk she is assuming when she gets out of that risk free rate. As you can see in the chart below, the risk premium for the S&P500 is negative for the first time in 23 years. It is telling you that the equity market is expensive relative to bonds, and that a rational investor should be a net seller of equities in favor of bonds. Of course, life is not that simple, but when you have an indicator that has not given you a signal in 20 years, suddenly starts flashing red, perhaps we should listen to the warning.
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