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Bush's war on terror and the new geopolitical risk premium.

The U.S. equities market has been selling at about a 30 percent discount on average since the third quarter of 2002. This represents the geopolitical risk premium that investors demand in order to own U.S. equities. During that quarter, corporate profits increased by 25.3 percent on an annual basis, but the S&P 500 index declined by 21.6 percent. Between that time and now. profit growth continued at a torrential pace. averaging 16.8 percent. That's more than double the growth rate of the entire post-World War II era. Equity prices, however, never came close to reflecting these tremendous gains in earnings because, since September 2002. investors require much higher earnings yields (relative to the benchmark ten-year Treasury yield) than before.

The figure below compares the S&P 500 earnings yield with the ten-year Treasury bond yield, It shows that, beginning in September 2002--and for the first time since Ronald Reagan's first election--investors required from equities a higher earnings yield than the benchmark bond yield. The event marked a dramatic shift in risk perception, which can be attributed to one thing only: fear of what the Bush Administration has variously called "The Long War" or the War on Terror.

Despite current heightened concerns over the effect of interest rates on U.S. equities, geopolitical risk premium is the real elephant in the living room no one is discussing.

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Title Annotation:OFF THE NEWS; George W. Bush
Author:Zoakos, C.
Publication:The International Economy
Article Type:Brief article
Geographic Code:1USA
Date:Jun 22, 2006
Words:234
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