Category Archives: Financial markets

From Main Street to Wall Street

My book – From Main Street to Wall Street (link) – has been published. This blog post explains why I wrote the book and its contents. The next three posts (that will be sent out in due course) will present some of the analyses and conclusions from the book.


Let me start in 2008. The financial crisis was at its worst.

I was a young professor of finance. I studied financial crises (my Ph.D. is on currency crises) and the relation between the macroeconomy and expected stock returns.

One day, I was invited to a TV program. I was asked to explain something in relation to the crisis. I do not remember the exact topic, but the appearance revealed that I have an ability to explain complicated financial issues in simple terms. There was a need for people with such skills, as many found it difficult to understand what was going on during the financial crisis. I decided that it was part of my duty as a professor at a publicly funded university to help people understand the complicated interactions between the financial sector and the real economy that were brought to surface during the financial crisis. Back then, I became something like an “academic TV star” in Denmark.

A couple of years after the crisis, in 2012, the then Danish government established a commission. Its task was to evaluate the causes and consequences of the financial crisis in Denmark. Due to my presence in the Danish debate and my research on this area, I was asked to be its chairman. I accepted the offer.

The next couple of years, I worked day and night. The report – today called the “Rangvid-report” (link) – was published in autumn 2013.

The decision to write a book

At some point in 2015, or was it 2016, i.e. a couple of years after the report, I started talking to myself about my next big project. With “project financial crisis” completed, I felt I somehow needed a new project. I decided to write a book.

I did not want to stress myself. I have been writing when time has allowed it. Sometimes, I have been able to write a lot. At other times, several months have passed when I was not able to write anything. This has been fine. No stress. In fact, an enjoyable process.

What should its topic be? The obvious topic would have been the financial crisis, given my involvement here. But, as mentioned, I had just completed writing the report of the financial crisis, and everybody else were writing books on the financial crisis. It should be something different.

I am and always have been fascinated by financial economics. Economic growth determines so many things in life. Financial markets help people fulfill some of their big dreams: buy a house, save for retirement. I have done research on the relation between the macroeconomy and financial markets. I decided the book should deal with this.

I am an empirical economist. I have done formal theory when I was young, but I have to come to realize that I do not have a comparative advantage here. Hence, I wanted the book to be a fact-based book on the relation between the economy and financial markets.

I started investigating the market. I was surprised.

Every day, newspapers and business magazines cover the latest macroeconomic news, not least to help investors navigate financial markets. Is falling unemployment good for stocks because it indicates the economy is doing well? Or, is it bad because the central bank will then start tightening monetary policy, potentially hurting stocks? Will countries expected to grow fast provide higher returns? How will economic developments affect financial markets?

Given the attention academics and investors devote to understanding the economy and its impact on financial markets, it was somewhat surprising to me that no well-known book focusing on the relation between the economy and the stock market, and targeted towards a broader audience, existed. I decided that my book should aim at filling this gap.

Of course, there are related books. The one closest to mine is probably “The long good buy” by Peter Oppenheimer (link). I like to think that my book is more thorough and has a firmer anchoring in the academic theories, given my background as an academic and Oppenheimer’s as a practitioner. Also, my book has this structure with the long and the shorter run. Lastly, and probably most importantly, I carefully explain how we can use the insights from the theories and historical evidence to formulate predictions about the future. This being said, Oppenheimer’s book is a great extra reading if you are interested in these topics.

Other related books could be “Stocks for the Long Run” by Jeremy Siegel (link), “Expected Returns: An Investor’s Guide to Harvesting Market Rewards” by Antti Ilmanen (link), and “Financial Markets and the Real Economy”, edited by John Cochrane (link). These are all great books, but they cover different aspects of the topic. Siegel’s book is a description of the stock market on the long run, whereas my book relates the stock markets to the underlying economy, over the short and the long run. “Expected Returns” focuses on providing a comprehensive overview of theories of expected returns on different asset classes, whereas my book focuses on the relation between the macroeconomic and equity markets, over the long run and the business cycle. “Financial Markets and the Real Economy” is a collection of academic articles written by many different authors, i.e. it serves a very different purpose and targets a very different audience than my book, even when the title indicates the same topic.

Writing style

The book is written in a style similar to this blog. Of course, this is a blog, so my language here is sometimes less formal than what I use in the book, but the use of tables and figures to provide a fact-based background to the relation between financial markets and the economy is similar to this blog.

I decided that my book should be academic in nature, but written in a style that is accessible to a broader audience. For instance, the book does not contain formulas or equations, except like “Real equity returns = Nominal equity returns – inflation, “Equity returns = dividend yield + capital gains”, and the like. The book presents the academic theories relating to the different topics, but in a way that should be understandable for interested non-academic readers and students.

An important characteristic of the book is its reliance on the data. Figures and tables richly illustrate and back up arguments and theories. The book is empirical in nature.

I wanted the book to be reasonably comprehensive. Its purpose is to give the reader a thorough understanding of how economic activity affects equity returns. Also, in some chapters, equity returns are compared to interest rates and bond returns.

All chapters end with a checkpoint list that summarizes key insights.

Table of Contents

A guiding principle in the book is that movements in economic activity contain a long-run and a business-cycle component. Over the long run, economies grow. Over shorter horizons – over the business cycle – economic activity fluctuates. My book examines both the long-run relation between economic growth and stock returns as well as the business-cycle relation.

After a first part that introduces fundamental stylized facts and important concepts, the remaining parts of the book are structured around the long-run and short-run relations. In my book, the long run refers to multiple years or decades. The short run to months or a few years.

Over the long run, economies grow. The rate at which an economy grows over the long run is the determinant of whether a country is rich or poor. Expectations to developments in economic activity over the long run help us formulating expectations to returns from financial assets over the long run. When a 25-year old individual asks how much he/she should save to live a decent life after retirement, i.e. after many years, the answer will not least depend on what we expect financial assets to return over the next many years. And, the answer to that question in turn depends on how fast we expect economy activity to grow over the long run. The second part of this book explains what we know about long-run economic growth, about returns on stocks over the long run, and about the relation between long-run economic growth and stock returns.

Over the short run, economic activity fluctuates. Sometimes even substantially so. There are years when the economy is booming, unemployment is low, and times are good. At other times, in recessions, economic activity falls, people are laid off, and times are rough. The recurrent alternations between good times and rough times is the business cycle. Economic activity and the stock market share a common business-cycle pattern. The level of economic activity and the value of stocks rise and fall jointly throughout the business cycle. In order to understand why stock returns are sometimes high and why they are sometimes low, it helps to understand business-cycle fluctuations in economic activity. The third part of the book explains how economic activity and stock returns stocks are related over the business cycle. This part also describes monetary policy, as monetary policy plays an important role in understanding business-cycle fluctuations and stock markets. This part of the book also devotes one chapter to the financial crisis of 2008-2009, as an example of an economic and financial event that dramatically influenced economic activity and equity markets.

When we understand how economic activity relates to financial assets, over the long run and business cycles, we are better equipped to formulate expectations to future returns on financial assets, over the short run and over the long run. This is what the fourth part of the book deals with. It explains how economists judge the outlook for the economy, and it takes us through short-run and long-run stock-return predictability. I emphasize that there is considerable uncertainty surrounding return forecasts, but also that stock returns contain a small degree of predictability. Even if it seems small at first glance, it accumulates and has important implications for academics and practitioners alike.

A final, short, section contains my view on a few practical investment advices.

Publication process

Oxford University Press is the publisher of the book. OUP has done a great job setting up the book. It looks good. The cover is also cool. I am happy.

I handed in the manuscript in spring last year, right before corona arrived. This means that I did not manage to include a chapter on the corona-crisis. If there ever will be a second edition, it will include such a chapter. Until then, many posts on this blog describe different aspects of how the corona-crisis has affected the economy and stock markets.

I received the book in print a couple of weeks ago. It is a nice feeling having published a book.


This post has provided some background on why I wrote From Main Street to Wall Street and its contents. My next three posts will describe some of its key conclusions. The first post will be on the long-run relation between the economy and the stock market, the next on the business-cycle relation, and the final on how we can use those relations to say something about expected future returns.

Yields and inflation expectations

During the last couple of weeks, yields have been rising and stock markets falling. Standard market turbulence is not interesting for this blog – stocks go up and down, most of the time up, and yields fluctuate – but intriguing (and expected) patterns characterize recent events.

Everybody seems to agree what is going on markets these weeks: Vaccines are successful and being rolled out, so economies will open up soon, and Biden will get his stimulus package to the tune of USD1.9tn. These two things (an already strong economy when opening up and on top of that a large stimulus package) will lead to very strong growth during the second half of 2021. Inflation will rise and the Fed will have to tighten monetary policy. The expected rise in inflation and the policy rate leads to increases in yields today. This hurts stocks. These US developments spill over to other countries.

This story largely makes sense. Looking at the data, however, interesting outstanding issues remain.

The story

Inflation expectations have been on the rise since the start of the rally in April 2020. Figure 1 shows developments in expected average annual inflation in the US over the next five years and the yield on five-year Treasuries since April 1, 2020:

Figure 1. Yield on 5-year Treasuries and 5-year breakeven inflation rate. Daily data since April, 2020. Two percent inflation target indicated by dotted line.
Source: Fed St. Louis Database

From a low level, expected inflation rose strongly during the summer-2020 rebound in economic activity, i.e. from April until August, and then stabilized. Since the election of Biden in November, inflation expectations have been on the rise again, because of the expected arrival of vaccines and the stimulus package.

Today, early March 2021, financial markets expect US inflation to be 2.4% per year on average over the next five years. Early November, expected inflation was 1.6%. An increase of almost one percentage point over the course of four months.

An expected rate of inflation of 2.4% is above the Fed’s target rate of inflation of 2% (link). With its new policy, the Fed might allow inflation to exceed 2% for some time, following a period of low inflation, such that average inflation over time approaches 2% (link). But how much more than 2% inflation will the Fed allow before it reacts? At 2.4%, markets start speculating that the Fed will raise rates to keep inflation expectations anchored.

Yields on 5-year Treasuries (also shown in Figure 1) had not moved until a few weeks ago. This also makes sense. As long as inflation is below the Fed’s two percent inflation target and the economy is suffering from the corona-recession, nobody expects the Fed to raise rates. As inflation started exceeding the target, expectations of a Fed hike started to be priced in.

Yields on one- and two-year Treasuries have not started rising yet, whereas yields on Treasuries with a maturity exceeding five years (five-year, seven-year, ten-year, twenty-year, etc.) have increased markedly during recent weeks. This means that the Fed is expected to start raising the policy rate in a couple of years only.

The rise in yields has caused turbulence on stock markets. Volatility (standard deviation of daily changes in the Nasdaq index, for instance) was 1.1% during November and December 2020 but 1.4% during January and February 2021. The same goes for the SP500 (0.83% during the last two months of 2020 vs. 1.04% during the first two months of this year). Stocks suffer.


All this (yields rise when expected inflation exceeds the target of two percent) seems fine and makes sense. The complicating feature, however, is that ten-year yields (and twenty-year and thirty-year, i.e. yields on long-maturity securities) have been constantly rising in relation to shorter-term yields since markets calmed down in April 2020:

Figure 2. Yield on 10-year Treasuries minus yield on 5-Treasuries. Daily data since April, 2020.
Source: Fed St. Louis Database

In April 2020, 10-year yields were 25 basis points above 5-year yields. Today, they are 80 basis points above.

It is thus not a new thing that yields rise. Longer-term yields have been doing so for some time. The new thing is that other yields start to rise, and that the increase in longer-term yields has accelerated during recent weeks.

We have just argued that it makes sense that markets start speculating that the Fed will raise rates when inflation exceeds two percent, and yields consequently react. But expected inflation over the next ten (and five) years has been below 2% ever since the start of the corona crisis and up until the turn of the year. Nevertheless, yields on ten-year (and longer) securities have been rising since April.

It is instructive to split expected inflation over the next ten years into expected inflation over the next five years and the subsequent five years, i.e. years 1-5 and 6-10 (the latter is sometimes called “5-year, 5-year expected inflation” or “5y5y expected inflation”):

Figure 3. 5-year breakeven inflation rate, 10-year breakeven inflation rate, and 5-year,5-year forward inflation expectation. Daily data since April, 2020. Two percent inflation target indicated by dotted line.
Source: Fed St. Louis Database

Up until January 2021, expected inflation was generally below the 2% target rate of inflation. Shorter-term (1-5 years) expected inflation was lower than long-term expected inflation (6-10 years) but also rose faster. Still, ten-year yields rose while shorter-term yields did not.

Expected inflation over the next ten years is the average of the 5 year and 5y5y expected inflation.

The complication, thus, is that while it is fine and makes perfect sense that market reacts when expected inflation exceeds 2%, it is somewhat puzzling that some yields (longer-term) react when inflation is below 2% while other do not (shorter-term), even when shorter-term inflation expectations rise faster that longer-term expectations?

(Of course, other things, such as the real rate and risk premiums, determined yields, and I briefly discuss these below, but given that there is so much focus on inflation expectations these days, we need to complete that story first).

This issue is a little bit that either you say:

“Given that expected inflation was below 2% until December 2020, it makes sense that shorter-term yields were flat until the start of this year. When expected inflation over the next 5 years started exceeding 2%, 5-year yields started increasing and longer-term yields accelerated”.

Or you say:

“I believe ten-year yields have increased since April because inflation expectations have been increasing, recognizing that expected inflation was below 2%”.

You might be able to come up with a story explaining developments before January, i.e. long-term yields rising but not short-term, and expected inflation below 2%, but it is not straightforward. One story could be that people expected the Fed to keep rates low over the next couple of years, but raise them later. This story would not be based on expected inflation, though, as expected inflation was below 2%, both on the short and the long run.

Before corona

By the way, before we continue, there actually was some relation between expected inflation and yields before the corona crisis, as there generally is. Between autumn 2018 and the corona crisis, expected inflation was falling by close to half a percentage point:

Figure 4. 5-year breakeven inflation rate and 5-year,5-year forward inflation expectation. Daily data since January, 2018. Two percent inflation target indicated by dotted line.
Source: Fed St. Louis Database

And yields were falling, too, during the same period:

Figure 5. Yield on 10-year Treasuries and yield on 5-year Treasuries. Daily data since January, 2018.
Source: Fed St. Louis Database

Real yields

Have real ten-year yields been rising between April 2020 and January 2021, explaining the rise in nominal yields? No. The fact that inflation expectations have been rising faster than nominal yields means that real yields have been falling since April 2020. And, the fact that shorter-term inflation expectations have been rising even faster than longer-term inflation expectations means that short-run real yields have been falling faster than long-run real yields:

Figure 6. Yield on 5-year and 10-year Treasury inflation-indexed security. Daily data since January, 2018.
Source: Fed St. Louis Database

Where should we look?

Given that the relation between expected inflation and yields is tricky (appears to be there now, but was muddy before January), it seems we need to think in terms of risk premiums. This is difficult. Perhaps the inflation risk premium has risen. Perhaps investors before January were more uncertain about inflation after five years than about inflation over the next five years, and demanded a compensation for this. It does not seem the most plausible story, but it is of course a possibility.

The obvious thing to shout is probably “debt”. It seems too early to go down that route, though. I present no analysis here leading credence to this story. And, there are many other potential explanations. It might be debt. But it might also be demographics, productivity, uncertainties, etc. There are many possibilities. The one that faces a hard time is trying to explain all developments in yields since the start of this rally by rising inflation expectations.

Last piece of evidence

The fact that ten-year yields have been rising faster than short-term yields during this recession is not unusual. Historically, around recessions, ten-year yields rise more than short-term yields, either during or right after the end of recessions (sometimes even right before recessions). This is what we have been seeing since April. The slope of the yield curve becomes steeper around recessions:

Figure 7. Yield on 10-year Treasuries minus yield on 5-Treasuries. Monthly data since 1983. Recessions indicated by shading.
Source: Fed St. Louis Database

The point I have been trying to make here is that the increase in the slope of the term structure (long-term yields rising faster than short-term yields) might not be unusual, but it is difficult to explain developments since April by simply saying “inflation is coming”. Expected inflation helps you explain some things, but not all.


Yields are currently going up because inflation expectations have started exceeding the 2% target rate of inflation. People start expecting the Fed to react at some point. This is fine and make sense. But inflation expectations have been going up for longer, since April 2020, and so have long-term yields, even when inflation expectations remained below two percent. Why did some yields (long-term) rise while others did not (short-term) when inflation was expected to remain below two percent and short-term inflation expectations rose faster than long-term expectations?


It’s this time of the year. This post recalls events of 2020. It has been such an unusual year, so different from what we expected. Luckily, there seems to be light at the end of the very long and dark tunnel, and – I hope – that 2021 will be considerably more joyful than 2020.

2020 started out so well. The roaring twenties and all that. Wuhan was a city I had not heard of, corona a beer people tell me is best served ice-cold with a slice of lime (I do not drink beer, tough I do enjoy wine), and social distancing words we would only get to know too well. Today, we know that Wuhan is a Chinese city with more than eleven million inhabitants and a marketplace where it presumably all started, corona also means something terrible, and social interaction is an activity we have come to miss so dearly.

At the time of writing, app. 75 million cases of corona/COVID-19/SARS-CoV-2 have been confirmed globally and app. 1.7 million people have passed away because of corona. Most countries have been in lockdowns, many still are (again), and the social and economic costs of the crisis have been enormous.

I started this blog in April 2020. This had nothing to do with corona. I had wanted to set up a blog for some years (people ask me where I find time for this, and I really do not know, but seemingly I simply like writing economic stories and analyses). Starting the blog in April this year, however, naturally implied that many of the blog posts have dealt with various economic and financial aspects of the pandemic. In this post, I will review some of the learnings from 2020.

The worst recession on record. With the highest growth rate on record

The recession started in February 2020 in, e.g., the US. Initially, it was caused by a supply shock: lockdowns were imposed and firms could not sell their goods and services and households could not go shopping. In April, when the IMF released their Spring Outlook, they labelled it “The Great Lockdown”. This was a suitable label. The IMF also noted that “This is a crisis like no other” and that “many countries now face multiple crises—a health crisis, a financial crisis, and a collapse in commodity prices, which interact in complex ways”. As unemployment and bankruptcies increased, households and firm got nervous, and demand suffered, too.

The path of economic activity has been highly unusual. This graph shows the quarterly percentage changes in US real GDP since 1947:

Quarterly percentage changes in US real Gross Domestic Product. 2020 encircled.
Source: Fed St. Louis Database

2020 is very much an outlier. On average, from 1947 through 2020, real GDP has grown by 0.8% per quarter. Until 2020, quarterly growth had never exceeded 4%. Economic activity had never contracted by more than 2.6%. Then came the Great Lockdown. During the second quarter of this year, economic activity contracted by 9%. This is almost four times more than the otherwise worst contraction on record. In this sense, it was the worst recession ever.

It has also been the weirdest recession ever. During this recession, we have also witnessed the highest growth rate on record: economic activity expanded by 7.4% during Q3. This is twice as much as the otherwise highest growth rate on record.

This puzzling feature of the recession led me wondering what a recession really is (link). I expressed sympathy with members of the NBER Recession Dating Committee. They face a particularly difficult task this year. Should they conclude that we had one V in spring, with the recession ending in late April, and then a new V now, i.e. two separate Vs (VV), or that we have had one long recession with a double dip, i.e. a double-V (W)? Does it make sense to call it a recession when we experienced the fastest rate of growth in economic activity on record? If you conclude that the economy cannot be in recession when it expands at its fastest growth rate ever, then you must conclude that the recession ended during Q2. But, the NBER Recession Dating Committee has not called the end of the recession yet, i.e., officially, the recession is still ongoing.

You may ask why it is important to know whether the recession ended in April or whether it is still ongoing. The development in economic activity is what it is, whether we call it recession or not. It is important because a “recession” is such an important concept in economics. We inform the public, business leaders, students, and others about the characteristics and consequences of recessions. If a recession can contain the by-far strongest expansion of economic activity on record, we need to change our understanding of recessions.

The very unusual behavior of economic activity during Q2 and Q3 caused very unusual, and scary, developments in unemployment and related aspects of economic activity. This graph shows the monthly change in the number of unemployed in the US:

Monthly changes in the number of unemployed in the US. Millions. 2020 encircled.
Source: Fed St. Louis Database

During March, unemployment in the US increased by 16 million. Again, this was beyond comparison. Until March 2020, the number of unemployed had never increased by more than one million over one month. In March 2020, it increased by 16 million.

As the virus contracted during summer, unemployment fell. There has never been as fast a reduction in the number of unemployed as the one occurring during this summer. In May, the number of unemployed dropped by more than three million. Until May 2020, the number of unemployed had never fallen by more than one million over one month. In May 2020, it fell by more than 3 million. So, within a year, we have had the strongest-ever increase in unemployment, but also the largest-ever fall in unemployment. By far.

Such dramatic events happened all around the world. I documented this here (link) and here (link).

Inspired by these events, I did something admittedly nerdy. I calculated the probability that we would experience events such as these, given the historical data (link). I found the unconditional likelihood that we could see the increase in newly registered unemployed that we saw in spring to be 0.97 x 10^(-841). This is a zero followed by 841 zeroes and then 97. For all practical purposes, this is a zero-probability event. But it did happen. It was just very, very unusual.

The stock market

I use some of my time (a significant part, by the way) to try to understand the stock market. This has not been a straightforward task this year.

Today, the global stock market is 13% percent above its January 1 value, the US stock market is 18% higher, and the Danish stock market 29% higher (MSCI country indices). Given that we have been through the worst recession ever, and that the recession is not officially over yet, this is not what one would have expected prior to the events.

Then, on the other hand, in hindsight it is perhaps not so strange. The recession has been the worst on record, yes. But, we have also had the fastest growth in economic activity on record. I argued (link) that if we imagine that the recession ended in late April, when economic activity bottomed out, the behavior of the stock market fits perfectly well with the historical evidence on the behavior of the stock market.

Central banks have certainly played their role, too. When markets melted down in March, central banks intervened heavily. In contrast to the financial crisis of 2008, it was not banks that were in trouble this time, but firms. Firms could not sell their goods and services due to the lockdown. The limitless purchases of government bonds that central banks have become used to during and after crises thus probably did not do much good (evidence came out that central bank purchases of government bonds are less effective than we are often told, link ). What turned things around, instead, was the announcement on March 23 that the Fed would facilitate credit to firms (link). This was a new policy tool. It led to a complete turnaround of events. I produced this graph (I still think it is a supercool graph): 

Difference between yields on ICE BofA AAA US Corporate Index and 3-month Treasuries (Left hand axis) as well as the SP500 inverted (Right hand axis). Both series normalized to one on January 2, 2020. Vertical line indicates March 23.
Source: Fed St. Louis Database

The graph shows how the stock market lined up with credit spreads. Firms were suffering, and their credit spreads started widening, in late February. The stock market suffered. The Fed announced it would provide credit to firms on March 23. Credit spreads tightened. The stock market cheered. The graph summarizes how the Fed saved credit and equity markets. And, strikingly, the Fed did so by merely announcing they would intervene. Up until today, the Fed has not intervened a lot. In this sense, it was a “Whatever it takes moment of the Fed”.

It should be mentioned that the Fed announced other initiatives on March 23, too, such as the Main Street Lending Program (link) and the Term Asset-Backed Securities Loan Facility (link). The Corporate Credit Facilities were the ones that directly targeted corporate bonds, though. Due to the nature of this crisis, the stock market lined up with credit spreads during this crisis, as the above graph reveals, emphasizing the importance of the announcement of the Corporate Credit Facilities.

Eurozone troubles, or rather no Eurozone troubles

The fact that we have not had to talk a lot about the risk of a Eurozone breakup since summer has been a positive surprise. In spring, there was talk about the risk of a Eurozone crisis. Like so often before, Italian sovereign yields rose relative to German sovereign yields. There was reason to be anxious. I argued that “Some kind of political solution at the EU level would be needed” (link).

This we got. The European Union agreed on a “Recovery and Resilience Facility” (link) that includes both loans and grants. EU has moved one inch closer towards a common fiscal policy. Who will pay is not clear, but EU has shown solidarity. I believe this is positive. At the same time, the European Central Bank continued its interventions and bought a lot of Italian debt. This has kept yields on sovereign bonds low. Here is the Italian-German yield spread during 2020:

Italian yield spread towards Germany. Ten-year government bonds. Daily data: January 2, 2020 – December 21, 2020.
Data source: Thomson Reuter Datastream via Eikon.

Italian yields have been falling continuously since summer, when the EU agreed on its recovery plan. It is positive that we have not had to discuss Eurozone troubles. We have had so many other troubles. Whether this means that we do not have to discuss Eurozone troubles again at some point, I am less sure. But, that is for another day.

Banks have been doing OK

The risk of a Eurozone breakup did not materialize. Another risk that did not materialize was the risk of systemic bank failures. This is positive as well, as economic activity suffers so much more when banks run into trouble and credit consequently does not flow to its productive uses.

During the worst days in March, stress in the banking system intensified. For instance, the spread on unsecure interbank lending increased relative to secure lending:

The TED spread. Difference between 3-Month USD LIBOR and 3-Month US Treasury Bills. Daily data: January 2, 2000 – December 14, 2020. 2020 encircled.
Data source: Fed St. Louis Database.

Stresses lasted only a few days, though. During the financial crisis in 2008, on the other hand, spreads remained elevated for much longer. This time, trust in the banking system was quickly reestablished.

I think I am allowed to claim that this was one of the predictions I got reasonably right. In autumn 2019, when nobody knew about the upcoming crisis, I wrote a policy paper on the Nordic financial sector. It was presented in December 2019 and finally published in June this year (link). I argued that banks are safer today, compared to 2008. Some doubted my conclusion and said, “just wait until the next crisis, then you will see that banks are not safer today”. Well, few months later we had the worst recession ever. Luckily, though, we have not had bank-rescue packages and we have not had to bail out banks. Banks have been withering the storm. In some instances, banks have even been part of the solution by showing flexibility towards troubled firms. I am not saying everything is perfect, but I am saying that the situation has been very different from the situation in 2008. On a personal note, this made me happy, too, as it would have been somewhat embarrassing if banks had failed at the same time I published an analysis arguing that the banking sector is safer. This, luckily, did not happen. Instead, the banking system turned out to be far more resilient than in 2008, as I predicted.

You may add that the Fed rescued markets during spring, as mentioned above, and thereby rescued firms and subsequently banks. True, but there was certainly also tons of rescue packages in autumn 2008. Banks nevertheless failed in large numbers in 2008. They did not this time around. Perhaps, thus, we did learn something from the financial crisis of 2008, and have gotten some things right. This would be no small achievement.

US election and Brexit

There have been other events, for instance the US election and Brexit negotiations. In normal years, such events would potentially have been among the most important events for markets and the economy. This year, the pandemic has certainly been more important. I did manage to write a post on the US election and the stock market, though (link). I discussed evidence that stock markets perform better under Democratic presidents. Only time will tell whether the same will happen under Biden.  

I did not manage to find space to discuss Brexit, but we got a trade agreement on Dec. 24 (link). Hopefully, the EU and UK can now move on.

The cost of the crisis

It is impossible to summarize the pandemic in one number or one word. Hence, I will not attempt to do so. But, I did present a calculation of the expected cost of the crisis in Denmark (link). I arrived at DKK 336bn, or app. USD 10,000 per Dane. This calculation generated some attention in Denmark.

One can discuss every single assumption one needs to make when calculating the expected cost of a crisis: What is the value of a statistical life? What is the value of a statistical life of those who pass away due to COVID-19, i.e. who are typically above 80? What is the past loss as well as the expected future loss in economic activity due to the crisis? Does it make sense to present one number when there is so much uncertainty? And so on. These are all fair points, but if we want to have a meaningful discussion of the impact of the crisis, we have to start somewhere.

In my calculation, I closely followed the assumptions of Cutler & Summers, such that US numbers and Danish numbers can be compared. This allowed me, for instance, to conclude that the cost of the crisis in Denmark, most likely, will be much lower than the cost of the crisis in the US.


I must admit I find it difficult to end this last post of 2020 on a happy note. Right now, at the time of writing, the situation is bad in the country I live, Denmark, and in many other countries in Europe and around the world. Numbers of new cases and deaths have been rising recently, or are on the rise again, and more and more restrictions and lockdowns are being imposed. Days are grey and short. The crisis has already been tremendously costly and it is clearly not over yet.

Nevertheless, I will try to end the post on a positive note. It gives me hope that several countries have started vaccinating people, and it seems to be working well. Finally, the EU also starts vaccinating people now. This has taken way too long, however, given the severity of the crisis and the fact that other countries started weeks ago. And, yes, every day counts. If it is correct, though, and I deliberately write if, that the EU has failed when it comes to the approval process and purchase of vaccines, as the normally well-informed and serious magazine Der Spiegel claims (link), it is a scandal. Biden aims to vaccinate 100m Americans within his first 100 days in office (link), close to a third of the US population. As things look now, it seems unlikely that we will be able to achieve the same in Europe. Christmas is all around us, though, so let us hope that somehow things will develop in the right direction.

Therefore, let me focus on the bright side. With the jabs, the situation will most likely start to improve within a not too distant future. I will try to convince myself that I see weak light at the end of the long and dark tunnel, even when we probably have to wait many months before things really calm down. Days are at least getting longer. I will focus on this, then.

With this, which is meant to be a positive message, let me thank you all for reading this blog and for sending me many encouraging mails with feedback. Please keep on doing so – it is highly appreciated.

I conclude by expressing hope that next year will be considerably more joyful than the one we leave behind.

Happy New Year!

Expected returns, autumn 2020 updates

Today, October 1, the Council for Return Expectations publishes its updated expectations. We expect very low – negative – returns on safe assets over the next five and ten years. We expect an equity premium around 5-7 percent.

I chair the Council for Return Expectations (link). Twice a year, we update our expectations. Today, we publish our latest forecasts.

In a June post (link), I described the history of the council, how we operate, who we are, why we publish expected returns, what they are used for, and so on. Briefly, here, the Council consists of Torben M. Andersen (professor of economics, University of Aarhus; link), Peter Engberg Jensen (former CEO of Nykredit and current chairman of Financial Stabilitet; link ), and myself as Chairman. Based on inputs from Blackrock, J.P. Morgan, Mercer, and State Street (thanks!), we estimate expected returns, risks (standard deviations), and correlations between returns on ten different asset classes over the next five and ten years. We also publish expected returns on two assets classes (stocks and bonds) for investment horizons exceeding ten years.

The forecasts are important in Denmark. When Danish pension funds project how the retirement savings of their customers will most likely develop (with confidence bands), they base their projections on the Council’s return expectations. Similarly, when banks advice Danish investors on their non-retirement savings, they use the expected returns provided by the Council. I think it is fair to say that Denmark has been a front-runner in designing a system where banks and pension funds do not compete on expected returns, but all use a common set of return assumptions, determined by an independent Council.

The forecasts published today will be used for pension projections and projections for savings outside retirement accounts as of January 1, 2021. In spring 2021, we will publish updated expectations that will be used from July 1, 2021, and the following six months. And so on.

The timing is as follows. The expectations we publish today are based on market data from July 1, 2020. We use the period from July 1 until today (October 1) to determine our expectations. The expectations we publish today are then used by banks and pension companies as of January 1, 2021.

The numbers

We publish forecasts for expected returns on ten asset classes over the next five years, years 6-10, and over the next ten years. Returns are average annual returns in Euros/Danish kroner (the Danish kroner is fixed to the euro). These are our expectations:

Source: Council for Return Expectations

We expect an investment in safe assets (defined as a five-year duration portfolio of 30% Eurozone government bonds (minimum Triple-B), 20% Danish government bonds, and 50% Danish mortgage bonds – Danish mortgage bonds are triple-A rated, by the way) to lose money every year on average over the next ten years. This is noteworthy. On average, we expect such an investment to lose 0.1% per year over the next ten years. Over the next five years, we expect it to lose 1.2% per annum. The reason why we expect such low returns is that the underlying bond portfolio has a duration of five years, as mentioned, and we expect a normalization of interest rates, causing capital losses which drag down expected returns.

We expect lower returns from bond investments than we did in our June update (link). In June, we expected government and mortgage bonds to return a negative 0.3% per year over the next five years and a positive 0.3% per year over the next ten years. The reason why we expect lower returns now (-1.2% and -0.1% for the five and ten year periods, respectively) is that our forecasts today, as mentioned, are based on market data from July 1. On July 1, interest rates and credit spreads were lower than those used at our previous update. Our previous update was based on March 31 market data. In March, the corona virus had caused a hike in yields and a widening of credit spreads. Since then, yields and spreads have come down.

Global equities are expected to yield around 6% per year. This means that the equity premium is expected to be 5%-7%, depending on the investment horizon.

We expect low inflation. We expect Danish inflation to be 1.2% per annum over the next five years and 1.5% over the next ten years.

For investment horizons above ten years, we expect equities to return 6.5% per annum and bonds 3.5%. This is the same as we expected last year (we update long-run expectations once a year). Over the coming year, we will make a thorough evaluation of these long-run expectations.

We also publish standard deviations for all asset classes and for all horizons, as well as correlations and fees. Standard deviations are high for high-return assets; nothing comes for free. We thus publish many numbers. You can find all these numbers on the webpage of the Council: link.


We (The Council for Return Expectations) expect that Danish investors will lose money – even before fees and inflation – if investing in safe assets over the next ten years. You can expect positive returns on other asset classes, but then you need to take on risks.

Historically, the risk-free real interest rate has been around 2% per annum and the nominal interest rate around 4%. Investors would see their savings grow, even without taking on risk. This is not what investors should expect going forward. The fact that you cannot expect your portfolio to grow without taking on risk tells us a lot about the low-return world we are living in.

Expected returns

The Council for Return Expectations published its forecasts of expected returns last week. There is a wide dispersion across asset classes. Returns on “safe” assets (government bonds) are expected to be very low, even negative, on the short horizon, whereas emerging markets equities are expected to return close to ten percent per year. The Council also publishes forecasts for standard deviations, correlations, and inflation.

As one of my external activities, I chair the Council for Return Expectations (link). The Council estimates expected returns, standard deviations, and correlations on ten broad asset classes. The estimates are widely used in the Danish financial sector and public discussions. Danish pension funds use the estimates when they calculate pension projections for their customers and banks use them when they make projections for how outside-pension savings can be expected to develop. Newspapers also write about them, too.

I will argue that the Danish financial sector has been a front-runner in designing a way to make such independent return assumptions. I hope the set-up helps improving the credibility of the projections banks and pension funds make.

In this blog post, I present the latest estimates from the Council. As it is the first time I present these estimates on this blog, I start out describing why the Council was established, how the Council works, and the procedure we use in the Council to find expected returns. Afterwards, I present the forecasts.

Background: The Council for Return Expectations

The Council was established (under a slightly different name) two years ago. The background was as follows.

Danes have large pension savings. Together with the Netherlands, Denmark has the largest pension savings in the world relative to GDP (We have a paper describing some of the key features of the Danish pension system here; link). Historically, pension savings have been guaranteed, meaning that pension holders were guaranteed a minimum average annual return on their pension savings. Because of low interest rates, longer life-expectancies, etc., Danish pension funds have shifted into so-called market-based pension products during the last decade or so. In these products, there is no minimum guaranteed return. This allows the pension funds to invest more freely, hopefully enabling them to secure higher risk-adjusted returns. Basically, you go from a constrained to an unconstrained (or at least less constrained) maximization problem, which should lead to a better outcome. However, when a pension holder is not guaranteed a minimum return, the expected pension payouts during retirement will obviously become more uncertain. The assumed expected returns and risks on the different assets that pension funds invest in thus become even more important (compared to a guaranteed pension product) for an individual’s expected pension payments during retirement.

A couple of years ago, I was approached by the Danish pension industry and asked whether I would help them design a set-up that could be used to generate expected returns on pension funds’ investments. The result was the following: based on inputs from international financial institutions, present expected returns over the next ten years on ten different asset classes, as well as long-run (> 10 years) expectations on two assets classes (stocks and bonds), and update these forecasts annually. The pension industry judged that an independent committee should specify and regularly update the return expectations, in order to secure arms-length. They asked me if I would chair this committee. The Committee is now called the Council for Return Expectations

Last year, banks in Denmark asked whether we (The Council) would be able to expand the set of return assumptions. The background was – probably fair to say – a scandal in the largest bank in Denmark. Danske Bank had advised some of its customers to invest in an investment product that the bank itself expected would yield a lower return than a bank deposit. I.e., the bank had advised its customers to invest in a suboptimal product, given expected returns. It led to the resignation of the interim Danske Bank CEO (link). The Danish banking sector concluded that arms-length was needed in determining return expectations used for investments outside pension savings. They asked the Council if we could include return expectations for a shorter horizon (1-5 years, in addition to the 1-10 years horizon) and a more frequent update of the return assumptions (twice a year, instead of annually). These forecasts were published last week.

Procedure for determining expected returns

We provide forecasts for nominal returns on ten broad asset classes. Having done extensive research on the determinants of expected returns myself, I know that even within a precisely defined asset class, forecasters can disagree substantially on the outlook for the asset class. When designing the set-up, I thus suggested that return expectations should be based on an arms-length principle and take estimation uncertainty into account. We do this by basing our expectations on inputs from several international investment houses.

We (The Council) receive inputs from Blackrock, J.P. Morgan, Mercer, and State Street. We are truly thankful for their help.

Blackrock, J.P. Morgan, Mercer, and State Street provide their estimates of expected returns, standard deviations, and correlations on each of the ten asset classes for each of the different horizons to the Council. The ten asset classes for which we provide expected returns are:

  • Government and Mortgage Bonds
  • Investment-grade bonds
  • High-yield bonds
  • Emerging market sovereign bonds
  • Global equity (developed markets)
  • Emerging markets equity
  • Private equity
  • Infrastructure
  • Real estate
  • Hedge funds

The horizons are:

  • 1-5 years.
  • 6-10 years.
  • 1-10 years.

Returns are nominal. Estimates are for the arithmetic average annual return per year during the different horizons.

Returns are hedged into euros, i.e. are euro returns, except from emerging market equities and local currency emerging market debt that are unhedged (emerging market debt is 50%/50% local/hard currency). The Danish kroner is pegged to the euro, i.e. euro returns are basically also Danish Kroner returns. Returns are before fees, expect from the last four asset classes (private equity, Infrastructure, real estate, and hedge funds) that are after fees to the funds that manage these types of investments, but before the fees to the Danish pension/mutual fund that in turn invests in the private equity funds, hedge funds, etc.

In addition, we provide forecasts for Danish inflation based on inputs from a number of Danish forecasters (the Danish central bank, ministry of finance, etc.).

The Council consists of three people: Torben M. Andersen (professor of economics, University of Aarhus; link), Peter Engberg Jensen (former CEO of Nykredit and current chairman of Financial Stabilitet; link ), and myself as Chairman. Our job in the Council is to specify the relevant asset classes and their characteristics, choose methods used to weight the inputs together, come up with reasonable forecasts, communicate these to the public, etc.

Forecasts of expected returns

The following table presents our forecasts of expected annual returns for the next five years, the next ten years, and years six through ten:

Source: Council for Return Expectations.

Over the next five years, we expect “safe” investments (government bonds and Danish mortgage bonds) to return a negative 0.3% per year on a pre-fees, pre-taxes, and pre-inflation basis. This is a low return. On a net-of-fees, after-tax, and real-terms basis, it is even lower. In the Danish media, much was written about this number (-0.3%). For finance professors and professionals, the number is no big surprise given low interest rates, but for ordinary investors, the publication of numbers such as these from trustworthy sources helps communicating the message that it is difficult to earn a decent return these days without taking on risk.

On a more technical term, the return on this asset class is the return to a bond portfolio consisting of 50% Danish mortgage bonds (that are triple-A rated, as you probably know), 20% Danish government bonds, and 30% Euro government bonds, with a duration of five years.

There is a wide dispersion across the different asset classes. For instance, we expect emerging market equity to yield 9.5% per year. There is thus an almost ten-percentage point difference between the expected return on the safest asset class and the asset class yielding the highest expected return.

Notice also that we generally expect higher returns after five years. We expect higher interest rates, causing capital losses and thus low returns during the first five years, but then higher returns later on. This in itself helps raising expected returns on other asset classes.

Standard deviations

In the Council, we want to stress that estimates of expected returns are surrounded by uncertainty. To the finance professionals, this is obvious (though, one might sometimes have the impression that even professionals tend to forget this), but to the ordinary investor, this is even more important to emphasize. The ordinary investor might otherwise conclude that when expected returns on emerging markets is 9.5% per annum, but government bonds are expected to yield a negative 0.3% per annum, I better put all my money in emerging market equity. We want to stress that this is a risky strategy. This ambition has guided us when it comes to our estimation of standard deviations.

The expected returns we present are constructed as simple unweighted averages of the expected returns of Blackrock, J.P. Morgan, Mercer, and State Street, asset-class by asset-class. They also provide us with their expected standard deviations. We do not use the simple averages of these as our estimates of expected returns, though. Instead, we regress the standard deviations we receive from the investment houses on the expected returns received from the same investment houses. The standard deviations the Council presents are then the fitted values from this regression. The main objective we achieve by following this procedure is that we make sure that there is a clear relation between risks and returns.

The standard deviations surrounding the estimates of expected returns are here:

Source: Council for Return Expectations.

We expect a 3.5% standard deviation of government and mortgage bonds (over the next ten years) whereas we expect a 29.6% standard deviation surrounding the estimated returns to emerging markets equity. There is thus a clear relation between expected risks and returns. This clear relation also appears from this graph that plots risks on the ten asset classes against their returns (1-10 years horizon):

Source: Council for Return Expectations.

One might say that the price we pay from estimating standard deviations in this way is that some of the individual estimates of standard deviations might differ slightly from market consensus. As an example, our estimate of the standard deviation of global equity is around 14%. Market consensus probably is that this is a little higher, at 16%-17%. On the other hand, the advantage we obtain from proceeding in this way, as mentioned, is that we secure a clear relation between risk and returns.


We also present correlations between expected returns. Here they are for the first ten years:

Source: Council for Return Expectations

Correlations are simple averages of the correlations we receive from Blackrock, J.P. Morgan, Mercer, and State Street, asset-class by asset-class. The main thing to notice probably is that we expect all correlations to be positive. This is bad news for investors, one might argue, but we saw this during the March turmoil. In March, bonds and stocks both lost in value, i.e. bonds did not hedge the risk of stocks. Our correlations reflect this.

The correlations and standard deviations are used by the pension funds to calculate confidence intervals surrounding the individual’s expected pension income. I want to stress that it is advanced – and good! – that pension holders in Denmark not only learn about their expected pension income but also the uncertainty surrounding this expectation.


We expect the Danish rate of inflation to be 1.2% over the next five years and 1.4% over the next ten years.

All the numbers

All the numbers – means, standard deviations, correlations, for all the horizons, etc. – are available on the webpage of the Council (link). On this webpage, addition information about the Council can be found as well.


We live in low-interest times. Investors might be tempted to invest more risky in order to generate a decent return. But what are decent returns? And how much extra risk do investors incur when investing more risky? In most countries, you get one set of answers when you visit one pension fund/bank/financial advisor, but another set of answers when you visit a different pension fund/bank/financial advisor. This makes investors uncertain and do not help building trust between the financial sector and investors. The financial sector in Denmark has found a cool way of presenting independent/arms-length forecasts. I hope that other countries might be inspired from this way of addressing this important issue.


PS. In my last post (link), I wrote about a new paper I have written on the financial stability in the Nordics. The journal where the paper is published is now available (link). It contains my own article and articles on the banking union, bail-in debts, household debts, and macroprudential policy, as well as a number of enlightening discussions.