Since the financial crisis wreaked havoc in 2008, investors could rely on one particular relationship: when the S&P 500 gained, so too did the 10-year U.S. Treasury yield.
That makes sense. The yield curve should steepen as investor confidence increases. Yet that’s not happening right now. As Societe Generale points out, the S&P 500 has rebounded 22 per cent since early October, but 10-year bond yields have not, pushing equity risk premiums to unusually high levels.
“This is a new paradigm in the risk premium field, with the Fed triggering persistent distortion in U.S. Treasury yields,” strategist Roland Kaloyan noted. “The Fed’s commitment to a zero rate policy until 2014 has affected global markets by preventing the long-term bond yield from rising in a context of positive U.S. earnings momentum.”
The result: equities are very cheap relative to bonds. South of the border, the historical risk premium is 3.7 per cent. Today, it’s 5.6 per cent. The same situation is playing out in Canada. The historical average risk premium here is 3.3 per cent, but it’s now almost double that at 6.4 per cent.
In fact, this is happening in most of the developed world. The only countries that break from this new norm are the troubled ones: Ireland, Italy, Greece, Portugal and Spain. In these markets, bonds range from cheap, to extremely cheap, relative to equities.
All of this makes valuing equities that much harder.
