David Tepper Says Stocks are Still Incredibly Cheap

“David Tepper is on CNBC arguing that stocks are still a buy.

During his appearance, he held up a chart from the blog Liberty Street Economics, which is a blog hosted by the New York Fed.

The chart he shows shows the Equity Risk Premium, which is the gap between expected return on stocks vs. bonds.

Based on traditional measures of the Equity Risk Premium (ERP) stocks are about as cheap as they’ve been in 50 years, a function somewhat of ultra-low bond yields.

From the Liberty Street Economics blog, here’s an explanation of the ERP and the chart which shows that stocks are really cheap.

We surveyed banks, we combed the academic literature, we asked economists at central banks. It turns out that most of their models predict that we will enjoy historically high excess returns for the S&P 500 for the next five years. But how do they reach this conclusion? Why is it that the equity premium is so high? And more importantly: Can we trust their models?

The equity risk premium is the expected future return of stocks minus the risk-free rate over some investment horizon. Because we don’t directly observe market expectations of future returns, we need a way to figure them out indirectly. That’s where the models come in. In this post, we analyze twenty-nine of the most popular and widely used models to compute the equity risk premium over the last fifty years. They include surveys, dividend-discount models, cross-sectional regressions, and time-series regressions, which together use more than thirty different variables as predictors, ranging from price-dividend ratios to inflation. Our calculations rely on real-time information to avoid any look-ahead bias. So, to compute the equity risk premium in, say, January 1970, we only use data that was available in December 1969…..”

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