Equity risk premium gravitational pull confirmed

Two weeks ago we could see the surge of the European equity risk premium at 8.3% (21-year average at 6.8%). At the same minute, we were anticipating (sadly) a drop as AlphaValue analysts were hard at work trimming their earnings forecasts for this year and next. Then, 2020 earnings were seen down 21%.

This is now confirmed with an update of the ERP at 7.04% now that 2020 earnings are seen down 37%.

The discussion about where the ERP will land is about 2021 and next. The 45% EPS growth now expected in 2021 is probably on the high side but, above all, does not translate the fact that 2021 earnings have been cut by 24% in one month, down to €547bn.

More erosion is likely so that with a lower earnings outlook, our ERP (which is the IRR on future AlphaValue earnings that will match current valuations) is bound to fall further.  

Unless, that is, prices also fall. In both instances, the gravitational pull is still on.  

As we reminded 15 days ago, a high ERP is not a clear Buy signal as long as earnings expectations are not purged. It may well be so for 2020 earnings but there is presumably more work on 2021 and after, as the full extent of the disruption is a painful discovery process.

The short-term, missed output is reasonably easy to grasp; the longer term, i.e. what government intervention means for tomorrow’s earnings stream, is another more complex matter.

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