The Relative Valuation of US Equities at Bear Market Bottoms: A Perspective on the Equity Risk Premium

30 Pages Posted: 20 Oct 2011

See all articles by Robert A. Weigand

Robert A. Weigand

Washburn University School of Business

Robert R. Irons

Dominican University - Brennan School of Business

Date Written: September 30, 2011

Abstract

We investigate stock returns, earnings growth, interest rates and the relative valuation of US equities following the 22 major bear market bottoms from 1881-2011. We find that large, sustainable bull market returns are associated with market bottoms where stocks' earnings yield expands significantly (as P/E ratios compress below average). Market bottoms since 1950 have been associated with shorter bear markets, lower average market earnings yields and slower real earnings growth following the market bottom, but higher real stock returns over the next 10 years. Since 1950, equity values have grown significantly faster than earnings, resulting in compression of the market earnings yield and stock-over-bond risk premium. Stock returns have become gradually disconnected from earnings to the point that the earnings yield is no longer reliably mean-reverting, and thus no longer predictive of future equity returns. Although we estimate the real equity risk premium to be only 0.5% below its post-1950 average, in the low-inflation, low-yield environment, US equities are priced to deliver below-average real returns of approximately 3.5% per year for the coming decade.

Keywords: Forecasting Models, Stock Returns, Earnings Yields, Bond Yields

JEL Classification: C22, C53

Suggested Citation

Weigand, Robert A. and Irons, Robert R., The Relative Valuation of US Equities at Bear Market Bottoms: A Perspective on the Equity Risk Premium (September 30, 2011). Available at SSRN: https://ssrn.com/abstract=1946801 or http://dx.doi.org/10.2139/ssrn.1946801

Robert A. Weigand (Contact Author)

Washburn University School of Business ( email )

Topeka, KS
United States

Robert R. Irons

Dominican University - Brennan School of Business ( email )

7900 West Division St.
River Forest, IL 60305
United States

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