One would have to go back to the days of Disco, tight polyester and Saturday Night Fever to have seen the Equity Risk Premium as high as it is today.
In a nutshell the Equity Risk Premium is a measure of the value of the stock market versus the risk free rate of return like a Treasury Note. As I’ve said in previous blog entries US equities are very inexpensive selling at 12x 2012 earnings versus the 50 year average of 15.5x. But under normal conditions the risk free rate of return could be in a range of 4% to 7% not the 1% or 2% that exists today. Hence the combination of ultra low risk free returns compared to low equity valuations has created an environment where equities could easily rise by 20% in 2012 just to reach average relative valuations.
In other words……..get ready for a big 2012, where small caps revert to their normal market leading position.
More to come in our forthcoming quarterly letter.