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How Do Countries Around the World Compensate for Equity Risk?

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Equity Risk Premiums

Equity Risk Premiums

How Do Countries Compensate Investors for Equity Risk?

When investors purchase stocks internationally, they are exposed to additional risks. Companies may have higher volatility based on a country’s economic, political, and legal conditions. In exchange for taking on the additional risk, investors demand a higher return potential, known as an equity risk premium.

Which countries have the highest premiums? In this Markets in a Minute from New York Life Investments, we explore equity risk premiums for countries around the world.

Behind the Numbers

The premiums are based on a study by a New York University researcher, Aswath Damodaran. All data is as of July 1, 2020.

Here are the steps Damodaran took to determine a country’s equity risk premium:

StepExample - Brazil
1. Find a country’s credit (bond) risk rating.Credit risk rating: Ba2
2. Based on that rating, determine the credit spread, which is the additional yield over a risk-free investment.Credit spread for Ba2 rating = 3.53%
3. To account for the additional risk stocks carry over bonds, multiply the credit spread by the relative equity market volatility.

This is the country risk premium.
3.53% credit spread x 1.25 relative equity market volatility

= 4.41% country risk premium
4. Add the country risk premium to the mature market risk premium (obtained by using the S&P 500 risk premium).4.41% country risk premium + 5.23% mature market risk premium
5. The resulting value is the country equity risk premium.9.64% country equity risk premium

Premiums will shift over time as a country’s credit rating, credit spread, and equity market volatility changes.

Equity Risk Premiums by Country

Below, we look at how equity risk premiums break down for 177 countries and regions, organized from highest to lowest.

CountryEquity Risk Premium
Sudan27.14%
Venezuela27.14%
Yemen, Republic27.14%
Algeria22.86%
Argentina22.86%
Guinea22.86%
Haiti22.86%
Korea, D.P.R.22.86%
Lebanon22.86%
Liberia22.86%
Somalia22.86%
Syria22.86%
Zambia22.86%
Zimbabwe22.86%
Ecuador19.92%
Congo (Republic of)18.46%
Cuba18.46%
Iran18.46%
Libya18.46%
Malawi18.46%
Mozambique18.46%
Sierra Leone18.46%
Barbados16.25%
Belize16.25%
Congo (Democratic Republic of)16.25%
Gabon16.25%
Guinea-Bissau16.25%
Iraq16.25%
Angola14.79%
Belarus14.79%
Bosnia and Herzegovina14.79%
El Salvador14.79%
Gambia14.79%
Ghana14.79%
Madagascar14.79%
Maldives14.79%
Mali14.79%
Moldova14.79%
Mongolia14.79%
Myanmar14.79%
Nicaragua14.79%
Niger14.79%
Pakistan14.79%
Solomon Islands14.79%
St. Vincent & the Grenadines14.79%
Suriname14.79%
Tajikistan14.79%
Togo14.79%
Ukraine14.79%
Bahrain13.32%
Benin13.32%
Burkina Faso13.32%
Cambodia13.32%
Cameroon13.32%
Cape Verde13.32%
Costa Rica13.32%
Egypt13.32%
Ethiopia13.32%
Guyana13.32%
Jamaica13.32%
Kenya13.32%
Kyrgyzstan13.32%
Nigeria13.32%
Papua New Guinea13.32%
Rwanda13.32%
Sri Lanka13.32%
Swaziland13.32%
Tunisia13.32%
Uganda13.32%
Albania11.84%
Bolivia11.84%
Cook Islands11.84%
Greece11.84%
Honduras11.84%
Jordan11.84%
Montenegro11.84%
Tanzania11.84%
Turkey11.84%
Uzbekistan11.84%
Armenia10.52%
Bangladesh10.52%
Côte d'Ivoire10.52%
Dominican Republic10.52%
Fiji10.52%
Macedonia10.52%
Oman10.52%
Senegal10.52%
Serbia10.52%
Vietnam10.52%
Azerbaijan9.64%
Bahamas9.64%
Brazil9.64%
Croatia9.64%
Cyprus9.64%
Georgia9.64%
Namibia9.64%
Guatemala8.90%
Morocco8.90%
Paraguay8.90%
South Africa8.90%
Trinidad and Tobago8.90%
Hungary8.46%
India8.46%
Italy8.46%
Kazakhstan8.46%
Montserrat8.46%
Portugal8.46%
Romania8.46%
Russia8.46%
St. Maarten8.46%
Andorra (Principality of)8.03%
Bulgaria8.03%
Colombia8.03%
Curacao8.03%
Indonesia8.03%
Philippines8.03%
Sharjah8.03%
Uruguay8.03%
Aruba7.58%
Mauritius7.58%
Mexico7.58%
Panama7.58%
Slovenia7.58%
Spain7.58%
Thailand7.58%
Turks and Caicos Islands7.58%
Laos6.99%
Latvia6.99%
Lithuania6.99%
Malaysia6.99%
Peru6.99%
Bermuda6.48%
Botswana6.48%
Brunei6.48%
Iceland6.48%
Ireland6.48%
Malta6.48%
Poland6.48%
Ras Al Khaimah (Emirate of)6.48%
Slovakia6.48%
Chile6.26%
China6.26%
Estonia6.26%
Israel6.26%
Japan6.26%
Saudi Arabia6.26%
Belgium6.12%
Cayman Islands6.12%
Czech Republic6.12%
Guernsey (States of)6.12%
Hong Kong6.12%
Jersey (States of)6.12%
Macao6.12%
Qatar6.12%
Taiwan6.12%
Abu Dhabi5.96%
France5.96%
Isle of Man5.96%
Korea5.96%
Kuwait5.96%
United Arab Emirates5.96%
United Kingdom5.96%
Austria5.81%
Finland5.81%
Australia5.23%
Canada5.23%
Denmark5.23%
Germany5.23%
Liechtenstein5.23%
Luxembourg5.23%
Netherlands5.23%
New Zealand5.23%
Norway5.23%
Singapore5.23%
Sweden5.23%
Switzerland5.23%
United States5.23%

Venezuela, Sudan, and Yemen are tied for the highest equity risk premium. While Venezuela battles hyperinflation, Yemen is suffering from a humanitarian crisis and Sudan has high perceived corruption.

In the mid-range, emerging countries such as Brazil, South Africa, and India carry moderate risk. However, they may also provide investors with higher returns than can be expected in mature markets.

On the low end of the scale, countries such as the United States, Singapore, and Germany have AAA credit ratings and the lowest premium of 5.23%.

Applying Risk Premiums to Companies

How can investors determine the equity risk premiums for individual companies?

One method is to assume that all companies incorporated in a country have equal exposure to that country’s risk. However, this is a simplified approach and does not account for the fact that a company’s operations may extend into other markets.

Alternatively, investors can calculate a weighted-average premium based on the location of a company’s revenue or production. For example, a consumer products business may weigh exposure based on the location of their revenue. An oil and gas company, where true risk lies in their reserves rather than where they sell, may instead be weighted by production.

Here’s a hypothetical example for an oil & gas company that has reserves in the United States, Saudi Arabia, and Venezuela:

CountryProduction (in kboed)*% of TotalEquity Risk Premium
U.S.6020%5.23%
Saudi Arabia12040%6.26%
Venezuela12040%27.14%
Total300100%14.41%

* Kilobarrels of oil equivalent per day.

The weighted-average equity risk premium is 14.41%.

Importantly, even countries headquartered in mature markets have international risks if they carry out operations in other countries.

Risk Vs. Potential Reward

Every country presents varying degrees of risk based on local conditions. As investors look to diversify internationally, it’s critical to consider two factors:

  • The additional risk
  • The potential additional return

Equity risk premiums serve as a guide that can help investors compare country risk, and the additional return potential they should expect for tolerating that risk.

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Markets in a Minute

Wall Street vs Main Street: The Stock Market is Not the Economy

To give context to the Wall Street vs Main Street debate, we compare S&P 500 returns and U.S. GDP growth since 1980.

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Wall Street vs Main Street

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Wall Street vs Main Street

In 2020, the stock market and the economy had a very public break up. The Wall Street vs Main Street divide—the gap between America’s financial markets and the economy—was growing. By the end of the year, the S&P 500 Index closed at a record high. In contrast, 20 million Americans remained unemployed, up from 2 million at the start of the year.

Was 2020 an outlier, or does the performance of the stock market typically diverge from the economy? In this Markets in a Minute chart from New York Life Investments, we show U.S. economic growth and stock market performance over the last four decades, to see how closely the two relate.

GDP Growth and S&P 500 Returns

Here’s how annual GDP growth and S&P 500 Index returns stack up from 1980 to the second quarter of 2021. Both metrics are net of inflation.

YearReal GDP GrowthReal S&P 500 Returns
1980-0.3%13.9%
19812.5%-18.3%
1982-1.8%10.8%
19834.6%13.4%
19847.2%-2.5%
19854.2%23.0%
19863.5%12.9%
19873.5%-2.2%
19884.2%7.9%
19893.7%22.4%
19901.9%-12.4%
1991-0.1%23.4%
19923.5%1.4%
19932.8%4.4%
19944.0%-4.2%
19952.7%31.4%
19963.8%17.2%
19974.4%29.3%
19984.5%25.1%
19994.8%16.6%
20004.1%-13.5%
20011.0%-14.6%
20021.7%-26.0%
20032.9%24.5%
20043.8%5.8%
20053.5%-0.7%
20062.9%11.4%
20071.9%-0.6%
2008-0.1%-39.2%
2009-2.5%21.6%
20102.6%11.1%
20111.6%-3.1%
20122.2%11.6%
20131.8%28.3%
20142.5%10.9%
20153.1%-1.4%
20161.7%7.3%
20172.3%17.2%
20183.0%-8.1%
20192.2%26.8%
2020-3.5%14.9%
Q1 20211.5%4.5%
Q2 20211.6%5.8%

Note: For Q1 and Q2 2021, real GDP growth and inflation rates are quarterly rates and are seasonally adjusted.

More often than not, GDP growth and S&P 500 Index returns have both been positive. The late ‘90s saw particularly strong economic activity and stock performance. According to the White House, economic growth was bolstered by cutting the deficit, modernizing job training, and increasing exports. Meanwhile, increasing investor confidence and the growing tech bubble led to annual stock market returns that exceeded 20%.

In the selected timeframe, only 2008 saw a decline in both the stock market and the economy. This was, of course, caused by the Global Financial Crisis. Banks lent out subprime mortgages, or mortgages to people with impaired credit ratings. These mortgages were then pooled together and repackaged into investments such as mortgage-backed securities (MBS). When interest rates rose and home prices collapsed, this led to mortgage defaults and financial institution bankruptcies as many MBS investments became worthless.

Moving in Opposite Directions

What about when the Wall Street vs Main Street divide grows?

Historically, it has been more common to see positive GDP growth and negative stock performance. For example, real GDP grew by a whopping 7% in 1984 due to “Reaganomics”, such as tax cuts and anti-inflation monetary policy. However, the stock market declined as rising treasury yields of up to 14% made fixed income investments more attractive than equities.

On the other hand, in five of the six years with negative GDP growth, there have been positive stock returns. The most recent example of this is 2020. Real GDP declined by 3.5%, while the S&P 500 returned almost 15% net of inflation.

The Stock Market is not the Economy

There are a number of reasons why the stock market may not necessarily reflect what is happening in the economy.

  • The stock market reflects long-term views. A stock’s price factors in what investors think a company will earn in the future. If investors are confident in the likelihood of an economic recovery, stock prices will likely rise. In contrast, GDP growth is a hard measure of current activity.
  • Sector weightings in the stock market do not reflect their contributions to GDP. The stock market remained resilient in 2020 largely because technology, media, and telecom (TMT) stocks performed well. Despite making up 35% of the market cap of the largest 1,000 U.S. stocks, these companies only account for 8% of U.S. GDP. In contrast, hard-hit companies such as restaurants and gyms generate lots of jobs and contribute materially to GDP. However, many of these businesses accounted for a small portion of the stock market or are not even publicly listed.
  • Fiscal policy lags behind monetary policy. The U.S. Federal Reserve (Fed) can act quickly. For instance, the Fed bought $1.7 trillion of Treasury securities between mid-March and June 2020 to stabilize financial markets. On the other hand, fiscal support requires legislative approvals. The U.S. government initially provided large-scale economic stimulus through the CARES Act in March 2020, but further relief packages were stalled due to political disagreements.

While many factors are at play, the above can help explain the Wall Street vs Main Street divide.

Wall Street vs Main Street: Together and Apart

Over the last 41 years, the economy and the stock market have moved in opposite directions almost as often as they have moved in the same direction. Here’s a summary of their movements from 1980-2020.

 # of Years
Stock Growth, GDP Growth22
Stock Decline, GDP Growth13
Stock Growth, GDP Decline5
Stock Decline, GDP Decline1

Since 1980, these time periods of differing performance have never lasted more than three consecutive years. In fact, one economist described the stock market and the unemployment rate as two people walking down the street, tethered by a rope.

”When the rope is slack, they move apart. But they can never get too far away from each other.”
—Roger Farmer, University of Warwick economist

After their public breakup in 2020, the Wall Street vs Main Street divide appears to have healed. In the first two quarters of 2021, both the stock market and the economy saw growth. Perhaps it’s easiest to sum up their relationship in two words: it’s complicated.

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Markets in a Minute

Data Centers: Investing in the Infrastructure of the Future

Infrastructure refers to any asset that provides an essential service. In today’s interconnected world, data centers are exactly that.

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Data Centers

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Data Centers: Investing in the Infrastructure of the Future

Digital transformation is one of the world’s most prominent trends today.

For evidence, consider the growth in internet users worldwide. By 2023, 5.3 billion people (66% of population) will be using the internet, up from 3.9 billion (51% of population) in 2018.

This growth has resulted in an incredible amount of data being produced each day, whether its from streaming music on Spotify or buying goods on Amazon. But how is all this data being processed?

In this Markets in a Minute chart from New York Life Investments, we shed light on the importance of data centers, and why they should be considered as core infrastructure.

The Role of the Data Center

A data center is a facility that stores, processes, and disseminates data. There are thousands of them around the world, and collectively, they’re referred to as the “cloud”.

This puts data centers at the center of nearly everything we do online: e-commerce, communications, storage and back-up, and even online gaming. To gain a better sense of what this all looks like, the following table breaks down the storage capacity of the world’s data centers.

Segment2016 Storage Capacity (exabytes)2021 Storage Capacity (exabytes) 
Compute160470
Collaboration170400
Database & analytics150380
Enterprise resource planning180420
Video streaming50180
Social networking60160
Search engine30100
Other consumer apps70190
Total8702,300

Source: Statista (2021)

One exabyte is equal to one billion gigabytes, which means the world currently has 2.3 trillion gigabytes of total storage.

The largest segment is compute instances, which are cloud-based workstations used by data scientists. At the lower end of the scale are segments like video streaming (includes Netflix and Hulu) and social networking (think Facebook or LinkedIn).

Cloud Spending Reaches a Historic Milestone

For businesses that create and use data, moving to the cloud (as opposed to maintaining their own servers) has plenty of advantages like cost savings, flexibility, and security.

This is driving exponential growth in cloud infrastructure spending, which reached a record $130 billion in 2020. At the same time, spending on data center hardware decreased from $96 to $90 billion. These results are partly attributed to COVID-19, which forced many businesses to switch to a work-from-home operating model.

A survey conducted by 451 Research found that 40% of businesses had increased their usage of cloud services during the pandemic. In addition, 85% of those who were impacted indicated that the move would be a permanent one.

Data Centers are Infrastrcture

The scope of an infrastructure investor has historically been limited to companies in construction, energy, and transportation.

But what defines infrastructure?

It’s any physical system that is vital for an economy’s development and prosperity—and in a world where over 5 billion people are expected to be online by 2023, the data center is the perfect embodiment of that.

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