US equities’ IRR is on the “risk-return tradeoff line” while USTs overall yield stands well below the market line implying that USTs provide little yield pick up over cash relative to their risk. We proxy “risk” for each asset class by the historical annualized vol of monthly excess return over cash since 1989. In other words, US HY corporate bonds are currently providing slightly better risk-adjusted Internal Rate of Return relative to US equities or HG corporate bonds.
In other words, the compensation per unit of risk embedded across asset classes is currently similar to that seen in the second half of 2019 as the “risk-return tradeoff line” has experienced a roughly parallel shift since then.
How low is the current slope of the “risk-return tradeoff line” relative to its longer history? Figure 3 depicts this slope over time. The slope appears to have been on a declining trend since the Lehman crisis. It currently stands at 0.23, i.e. the “expected Sharpe Ratio” embedded across asset classes is 0.23 at the moment which is below its historical average since 1989.
In all, while risk premia have compressed across asset classes as interest rates rose sharply, we are still some way from the frothier risk premia backdrop of previous cycle peaks such as in 2007, 2000 or 1989.
- J.P. Morgan Quantitative Strategy
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