Dispelling another investment myth
Is a falling Equity/Risk Premium (ERP) bearish for stocks? No, it isn’t. Jay Kaeppel (HERE) debunks another investment fallacy by showing that a falling ERP does not influence the stock market. So, a relatively low yield of stocks vs. bonds has zero predictive power of future performance. Actually, as shown in the screenshot below, the stock market is up an average 9.57% after the ERP crossed below 0.5 (which means stocks "expensive" relative to bonds).
In trend following, our trade horizon seldom exceeds a year, making most fundamental measures, especially the equity risk premium, counterproductive to our performance. Paying too much attention to them can be detrimental to our portfolios. Our Composite Indicator, which is a trend-following indicator based on the Dow Theory for the 21st Century and the BlayTiming Indicator, made over +18% in 2023 by ignoring a persistently high ERP during 2023.
The moral of the story: Focus on price action, and don’t let yourself be
fooled by the noise.
Editor of thedowtheory.com