What this chart shows
This chart illustrates the real equity risk premium (ERP) of US equities, by plotting the inverted 1-year forward price-to-earnings (P/E) ratio (i.e. forward earnings yield) of the S&P 500 and subtracting the yield on 30-year US inflation-linked bonds. The result provides a historical perspective on how the compensation for taking equity risk, relative to the long-term real risk-free rate, has evolved over time.
A higher ERP implies that equities are offering greater compensation for risk, often due to pessimistic economic expectations or market volatility. Conversely, a lower ERP suggests confidence in growth prospects or an increased appetite for risk-taking, potentially signalling frothy equity valuations or tighter monetary conditions.
Over the period we can see key inflection points, such as the dot-com bubble (1999-2000), the global financial crisis (2008-2009), and the market turbulence following the COVID-19 pandemic (2020). Sharp increases often correspond to heightened investor uncertainty, where falling bond yields and reduced equity valuations boost the ERP. Conversely, declines suggest improved investor confidence, rising bond yields, or elevated equity valuations reducing the risk premium. The recent trajectory has been a combination of both these factors, increased equity valuations despite rising real rates.
Why this is important
A long duration asset such as a 30-year inflation linked bond offers a meaningful comparator when assessing the risk you are willing to bear as an equity investor. In the case of US equities, investors are only receiving a 2-percentage point risk premium over and above long-term inflation protected returns of over 2%. While earnings growth may be enough to offset both inflation and valuation compression over a period of three decades, the intervening period can be painful for investors.
For multi-asset investors, this measure can provide a key consideration for portfolio allocation and valuation analysis. The era of low interest rates distorted the investment landscape post the global financial crisis of 2008, making equities a consistently attractive option from a relative perspective, with few alternatives. The increase in interest rates over the last three years has inflicted significant pain on bond holders over this period of normalisation. While today’s 30-year US real yield of around 2.5% may not be a highly compelling proposition on an absolute basis, they are at their most competitive versus equities for over 20 years. This provides genuine diversification opportunities for investors, particularly in the light of elevated equity valuations.
The unveiling of DeepSeek's advanced AI model in China led to significant global market volatility, particularly impacting technology stocks and prompting a reassessment of competitive dynamics in the AI sector.
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Nasdaq Composite fell over 3% as Chinese startup DeepSeek unveiled a low-cost AI model, challenging US tech dominance and leading to significant declines in major tech stocks, including a 15% one-day drop in Nvidia shares.
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The Trump administration confirmed the implementation of 25% tariffs on imports from Mexico and Canada, and a 10% tariff on Chinese goods, citing concerns over immigration and drug trafficking.
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The Federal Reserve held its policy rate steady at a range of 4.25%-4.5%, with discussions emphasising the importance of rate stability over immediate cuts, given the economy's continued strong growth.
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Despite market volatility, several US companies reported robust earnings, contributing to investor optimism and partially offsetting concerns over international trade tensions.
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AstraZeneca announced the cancellation of its £450 million expansion project in Liverpool, attributing the decision to reduced government funding under the Labour administration.
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The FTSE 100 index had its strongest month since November 2022, buoyed by healthy earnings reports and interest rate cut expectations.
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UK house prices showed resilience, rising despite ongoing affordability pressures, indicating sustained demand in the housing sector.
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The UK's trade dynamics faced potential challenges due to the US imposing tariffs on Canada and Mexico, with concerns about possible ripple effects on global trade.
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European markets experienced another weekly gain, with the Euro Stoxx 600 rising by 1.8%, influenced by US policy changes under President Trump, including a focus away from European trade tariffs.
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The European Central Bank cut interest rates from 3% to 2.75% and left the door open for further rate cuts, contrasting with the US Federal Reserve's stable approach, contributing to a weaker euro and favourable export conditions.
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The EU proposed new customs reforms to hold e-commerce platforms like Temu, Shein, and Amazon liable for unsafe or illegal products sold online, aiming to enhance consumer protection.
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European tech stocks were affected by global market reactions to DeepSeek's AI developments, leading to a reassessment of valuations within the sector.
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Despite global market volatility, China's mainland blue-chip stocks showed resilience, with equities adding 1.1%, even after data indicated a surprise contraction in manufacturing.
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Chinese startup DeepSeek launched a free, open-source AI model rivalling Western counterparts, leading to significant impacts on global tech markets and challenging US tech dominance.
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The Japanese yen experienced a strong performance, driven by expectations of rate hikes from the Bank of Japan, influencing currency markets.
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Crude oil prices declined after President Trump reiterated calls for Organisation of the Petroleum Exporting Countries (OPEC) to reduce prices, with Brent crude futures dropping 2.2% to $78.5 a barrel.
