Equity Risk Premium (earnings yield minus 10y bond yields) is a theoretically effective way to evaluate the relative attractiveness of bonds vs. equities. In the U.S., falling bond yields have increased the ERP by almost 1.4 percentage points since last Oct. The increase has been much smaller in Europe (0.8 p.p.), because of a weaker earnings yield and a smaller fall in bond yields. As a result, the ERP spread between Europe and U.S., which has been steadily widening since 2013, is narrowing. This means U.S. equities have become less expensive compared to their European peers. However, as Treasury yields appear to be falling toward their European sovereign counterparts, U.S stocks may get even cheaper.
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