Thus, the same mean reversion that market bulls point to with the ERP can be used to make a bearish case for unique boutique s. In 1981, the ERP was 5.73%, but it was on top of a ten-year US treasury bond rate of 13.98%, yielding an expected return for stocks of 19.71%. On May 1, 2013, the ERP is at 5.70% but it rests on a US treasury bond rate of 1.65%, resulting in an expected return on 7.35%. An investor betting on ERP declining in 1979 had two forces working in his favor: that the ERP would revert back to historic averages and that the US treasury bond rate would also decline towards past norms An investor in 2013 is faced with the reality that the US treasury bond rate does not have much room to get lower and, if mean reversion holds, has plenty of room to move up, and if history holds, it will take the ERP up with it.
As I will argue in the next section, the high ERP in 2013 is very different from high ERPs in previous time periods and extrapolating from past history can be dangerous. There is nothing surprising about this balance sheet but it brings together much of what has happened to the company between April 2012 and April 2013. During the year, the company has become increasingly dependent upon its smartphone business, accounting for 60% of revenues and even more of operating income, generating immense amounts of cash for the company (with the cash balance climbing $50 billion over the course of the year to hit $145 billion). To keep my perspective, as I read these stories, I go back to basics and draw on my “financial balance sheet” view of a company. While it resembles an accounting balance sheet in broad terms, it is different on two dimensions. So what? While the relationship between the level of the ERP and the risk free rate has weakened over the last decade, the two numbers have historically moved in the same direction: as risk free rates go up (down), equity risk premiums have risen (fallen).