The gap between the S&P 500’s earnings yield and the yield on 10-year US Treasury notes has fallen to its lowest level since 2009, highlighting a shift in the relative appeal of equities and government bonds.
The annual spread has dropped to minus 1.5 percentage points, according to the figures in the market update. Since 2022, the difference has narrowed by 440 basis points, marking its largest five-year decline since the 1970s, the update states.
The shift means investors are currently receiving a higher yield from 10-year Treasury notes than from the S&P 500’s earnings yield, despite stocks carrying greater investment risk.
The equity risk premium measures the additional return investors expect from holding shares rather than a relatively safer asset such as government bonds. When the premium turns negative, Treasury yields exceed the earnings yield on equities, making bonds look more attractive on this measure alone.
The S&P 500’s equity risk premium is on track to record its third consecutive negative annual reading, which would be its longest such run since 2002, according to the market commentary.
However, the comparison does not mean Treasury bonds will necessarily deliver better total returns than shares. An earnings yield is calculated from company earnings relative to share prices, while a bond’s yield reflects the income investors can expect under specified conditions. Stock prices can rise or fall, and earnings can change, meaning the two measures are not directly equivalent.
Historically, negative equity risk premiums have been associated with strong investor appetite for risk and elevated equity valuations. The current spread may therefore point to stretched share prices relative to earnings, although it does not by itself establish that a market correction is imminent.
The market update anticipates an eventful fourth quarter, with investors likely to keep weighing equity valuations against bond yields as they assess the outlook for financial markets.
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