Every risk has a price, and in our view, markets are priced for different outcomes. Strikingly, the chart of the week shows bond risk premia now exceed equity premia for the first time since the Great Financial Crisis.
The gap has only twice been this wide in the last century – during the Great Depression and the Nasdaq tech bubble. The current differential has been driven by higher long-term rates (inflation breakevens and real yields have risen) and lower earnings yields as analysts have turned more bullish on expected earnings.
Relative valuations look extreme to our multi-asset portfolio management team, presenting attractive opportunities for active asset allocation. Their key risk positions are now an overweight versus their benchmark in sovereign bonds, chiefly in the US, and a modest underweight in equities, concentrated in Europe.
Click here to read our latest Asset Allocation Monthly entitled “Complacent? Not us”.