Jun

4

I periodically take a fresh look at the so-called "equity risk premium" for various global stock markets. There are many academic articles on this subject that are nearly useless for short-term market-timing, but quite helpful for long-term asset allocation. For example, here are two papers from a Google search on "Equity Risk Premium Across Countries":

Ibbotson, Chen: The Supply of Market Returns (2001) [30 page pdf]

or

Dimson, Marsh, Staunton: Global Evidence on the Equity Risk Premium, (2002) [17 page pdf]

What is the current situation? Examining the Bloomberg screenshot below, one notes that Japan has by-far the highest nominal risk premium. It's possible that this is due to their JGB yield at 1.28% — and if JGB yields increase by 100-200 basis points, the risk premium will decline by the same amount — reducing the apparent relative cheapness. Nonetheless, I looked at a handful of mega-cap Japanese stocks. When I plugged in a 1% growth rate and lowered the risk-premium to around 10-12%, the "theoretical" value of these stocks increased massively — in many cases predicting more than a doubling in valuation.I am NOT rushing out to blindly buy Japanese stocks, even though Toyota, Honda, Mitsubishi, UFJ, Canon, Sumitomo, Mitsui, Sony etc. model-up incredibly well on a Dividend Discount Model that assumes any positive GDP growth over the next decade.

But one wonders whether we are approaching trough valuations after a 20-year bear market? And, other than slow, trend-following technicals, what approaches would one use to make such a call?

Sushil Kedia adds:

If there is a larger risk premium in Yen terms, is it also the same in terms of Dollars?

What if Tokyo pits are pricing a much stronger Yen ahead in the year? Hungry mind is just generating possible explanations and keen to learn. With the JGB Yields being where they are for years, the real variation comes from the change in interest rates in the US treasuries. Is the Risk Premium in Japan a good way to start thinking of a theses that the interest rates in the world will be rising in other important places including the USA, later in the year?

Kim Zussman comments:

Here is log nikkei in USD. It appears US investors were less driftless than the Japanese.


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