{"id":4635,"date":"2011-08-11T08:13:22","date_gmt":"2011-08-11T14:13:22","guid":{"rendered":"http:\/\/www.jasonapollovoss.local\/?p=4635"},"modified":"2018-09-21T02:04:45","modified_gmt":"2018-09-21T06:04:45","slug":"equity-risk-premium-drill-down-indicates-bizarre-investor-behavior","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2011\/08\/11\/equity-risk-premium-drill-down-indicates-bizarre-investor-behavior\/","title":{"rendered":"Equity Risk Premium Drill Down Indicates Bizarre Investor Behavior"},"content":{"rendered":"

 <\/p>\n

Earlier this week in my post entitled, “Adjusting the Scale of the Selloff to Demonstrate Its Absurdity<\/a>,” I spent quite a lot of time talking about this thing called the “equity risk premium” and some of the interesting data I had calculated based on this measure.\u00a0 Today I wanted to drill down into that equity risk premium data because it indicates some bizarre investor behavior over the last 46 years.<\/span><\/p>\n

So what is the equity risk premium?\u00a0 It is based on the understandable theory that investing in the stock market is riskier than investing in the bond market.\u00a0 Why would this be so?<\/span><\/p>\n

Because bond holders have the legal right to the cash flows from a cash paying entity (e.g. a government, business, or individual).\u00a0 Further, in the event of bankruptcy bond holders are ahead of equity holders in terms of asset disposition.\u00a0 In other words, they get first dibs on the assets of the bankrupt entity that issued the debt.\u00a0 Think: car repossession or house repossession on the part of a bank.\u00a0 They have first dibs compared to the car owner if the owner doesn’t pay the bill.<\/span><\/p>\n

To take on these additional and certain risks equity holders require a higher rate of return than bond holders.\u00a0 Does this make sense?\u00a0 That higher rate of return required by equity holders is known as the equity risk premium<\/em>.<\/span><\/p>\n

One technical note before proceeding, the typical calculation of the equity risk premium is as follows:<\/span><\/p>\n

equity risk premium = earnings yield of the stock market – yield on 10-year U.S. Treasury Note<\/span><\/p>\n

The 10-year U.S. Treasury Note is usually used because stock market investing is generally considered to be a long-term activity.\u00a0 Here the assumption is that it will be for 10 years; that’s why you compare the earnings yield of the stock market to a 10-year U.S. Treasury Note and not a 5-year bond.\u00a0 Apples to apples, not oranges.\u00a0 Does this make sense?<\/span><\/p>\n

The reason that the earnings yield of the stock market is compared to a piece of U.S. Treasury debt is that for decades U.S. government debt has been considered to be the most riskless investment in the world.<\/span><\/p>\n

Now back to our regularly scheduled program…<\/span><\/p>\n

So the first logical conclusion that we could all make is that the equity risk premium should absolutely never be negative.\u00a0 If the equity risk premium were negative an investor could sell her or his equity investment (i.e. stock investment) and buy a bond that would pay her or him a higher rate of return and<\/em> be less risky.<\/span><\/p>\n

Yet, in the 130 years of monthly data regarding the S&P 500, dating back to January of 1881 the equity risk premium has been negative for 25.1% of the time (source: What My Intuition Tells Me Now<\/em> blog).\u00a0 Specifically, the equity risk premium has been negative for an entire month 393 times of 1568 possible months.<\/span><\/p>\n

Frankly, this result is very surprising and is very likely a strong indication of irrationality on the part of equity investors.<\/span><\/p>\n

But an alternative explanation might be that equity investors are, in fact, hyper-rational.\u00a0 Maybe the reason that they are willing to earn less on risky stocks than on a riskless bond is that they feel that the bond is actually riskier than popularly believed.<\/span><\/p>\n

The current debt crisis in the United States might be this kind of situation.\u00a0 That is, a period when people actually feel investing in a business, any business<\/em>, is less risky than investing in the debt of the United States.<\/span><\/p>\n

To see whether or not this kind of rationality can explain the fact that the equity risk premium has been negative 25.1% of the time you would have to look at the historical context when the equity risk premium has turned negative.\u00a0 Then you can better assess the smarts of the investment community.<\/span><\/p>\n

From January 1881 to August 2011 there have been a total of 28 turns in the equity risk premium.\u00a0 That is, times when it switches from positive to negative, or from negative to positive.\u00a0 Let’s look at each of those:<\/span><\/p>\n

Month \u00a0 \u00a0 \u00a0 \u00a0\u00a0 ERP Turns? \u00a0 \u00a0 \u00a0 \u00a0\u00a0 After Run of Length\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 What’s Going On Market History-Wise<\/strong><\/span><\/p>\n

Jan 1881\u00a0\u00a0\u00a0\u00a0 \u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 582 months<\/span><\/p>\n

Jul 1929\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 3 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 lead up to the great crash of 1929<\/span><\/p>\n

Oct 1929\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 431 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 the great crash of 1929<\/span><\/p>\n

Sep 1965\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 12 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Nifty Fifty era of growth stocks<\/span><\/p>\n

Sep 1966\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 2 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Nearly 20% correction of the S&P 500<\/span><\/p>\n

Nov 1966\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1 month<\/span><\/p>\n

Dec 1966\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 5 months<\/span><\/p>\n

May 1967\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 46 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 ~12% rise in the S&P 500, Israel’s Six Day War<\/span><\/p>\n

Mar 1971\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1 month<\/span><\/p>\n

Apr 1971\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 6 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Gold Standard<\/span><\/p>\n

Oct 1971\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 3 months<\/span><\/p>\n

Jan 1972\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 22 months<\/span><\/p>\n

Nov 1973\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 75 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Yom Kippur War and Subsequent Oil Embargo<\/span><\/p>\n

Feb 1980\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 2 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Runaway inflation and a recession<\/span><\/p>\n

Apr 1980\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 4 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Runaway inflation and a recession<\/span><\/p>\n

Aug 1980\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 19 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Recession ends<\/span><\/p>\n

Mar 1982\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1 month\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Recession<\/span><\/p>\n

Apr 1982\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1 month\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Recession<\/span><\/p>\n

May 1982\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1 month\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Recession<\/span><\/p>\n

May 1983\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 12 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 End of the recession<\/span><\/p>\n

Apr 1986\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 35 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Chernobyl nuclear disaster<\/span><\/p>\n

May 1986\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1 month\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 End of Chernobyl fears<\/span><\/p>\n

Jul 1986\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 2 months<\/span><\/p>\n

Sep 1986\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1 month<\/span><\/p>\n

Oct 1986\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1 month<\/span><\/p>\n

Nov 1986\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1 month\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Beginning of IT\/dot.com bubble, balanced budget under Clinton<\/span><\/p>\n

Sep 2002\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 190 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 End of dot.com bubble, September 11, Enron scandal, etc.<\/span><\/p>\n

Aug 2003\u00a0\u00a0\u00a0\u00a0\u00a0 Negative\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 11 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Beginning of Real Estate Bubble<\/span><\/p>\n

Jan 2008\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 53 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Real Estate Bubble POPS!<\/span><\/p>\n

Present\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Still positive\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 44 months\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 The Great Recession and post-Great Recession<\/span><\/p>\n

Source: What My Intuition Tells Me Now<\/em> blog and Jason Apollo Voss<\/span><\/p>\n

Forgive the very long enumeration above.\u00a0 However, what’s very interesting is to note the moments when switches between positive and negative happen.\u00a0 Almost all of the switches happen when there is major global or economic news.<\/span><\/p>\n

Particularly interesting is to see that when the equity risk premium goes negative the typical environment is not one of disaster, where a government’s debt might be called into question.\u00a0 No, instead the negative equity risk premium is strongly associated with stock market bubbles.<\/span><\/p>\n

Interestingly enough the bubble that led to the October 1929 crash was preceded by the first negative equity risk premium in history – 3 consecutive months worth.\u00a0 October 1929 was the first of 431 months of positive equity risk premium.\u00a0 Put another way, between January 1881 and August 1965, or 1,016 months, only 3 of them saw a negative equity risk premium.\u00a0 That’s a paltry 0.3% of the months over 84 years, 8 months!<\/span><\/p>\n

Then the equity risk premium turned negative again in 1965 as the “Nifty Fifty” stock market bubble started to take off.\u00a0 There was only a minor correction in 1966 and then much more negative equity risk premium until 1971.\u00a0 Again, there was a small correction, and then more negative equity risk premium until the recession and massive correction precipitated by the 1973 oil embargo.<\/span><\/p>\n

While there were small bursts of stock market lift-off, that 1973 stock market decline seemed to correct investors of their bizarre behavior until about 1983 and the end of the double-dip recession.\u00a0 Then until about 2002, or 19 years (!), there was near continuous negative equity risk premium.\u00a0 Remember, it only took 3 months of this in 1929 to trigger a massive sell off of equities.<\/span><\/p>\n

In fact, overwhelmingly, the negative equity risk premium years have happened since 1965 with 390 of the 393 months being logged since that turn in September 1965.\u00a0 Furthermore, since that fateful month the stock market has traded with a negative equity risk premium for 70.7% of the time through August 2011.\u00a0 This is stunning in comparison to the 0.3% of the time up until September 1965.<\/span><\/p>\n

What I am trying to highlight here is that the sort of bizarre behavior that led to the stock market crash of 1929 has been replicated at a 130x magnitude since September 1965!\u00a0 What has propelled this gigantic, truly massive stock market bubble?\u00a0 There are myriad answers, but here is a sampling:<\/span><\/p>\n