- The stock market has enjoyed a remarkable run, with the S&P 500 up about 17% this year.
- But compared with bond yields, the return on stocks is at its lowest for more than 13 years.
The stock market's having a good year, but one metric suggests that investors may not be getting the best value for their money.
The equity risk premium measures the bonus an investor can expect to earn for investing in the stock market over a risk-free 10-year Treasury bond.
The premium has fallen to the lowest level since 2009, which could indicate a warning sign for equity investors.
Markets strategist Charlie Bilello tweeted a graph mapping the S&P 500 earnings yield, minus the return from 10-year Treasurys – with the 2023 ratio standing at just 0.4%.
—Charlie Bilello (@charliebilello) August 29, 2023
"Signal or noise?" he asked viewers in an accompanying YouTube video.
Stocks require a higher expected return to compensate investors for the risk of fluctuating returns, as opposed to a bond that pays out a fixed amount at maturity.
And when Treasury yields rise, they become more attractive to investors relative to stocks because they offer similar returns for less risk.
Bilello cautioned against reading too much into the tea leaves, however.
"Today stocks are not very cheap. Bonds are kind of average yields, but we know they've been rising and people are trying to draw some signal out of this," he said in an interview with Peter Mallouk, CEO of wealth management firm Creative Planning. "I would caution against that for sure."
Despite the weak risk premium, stocks have had the upper hand on bonds this year. The S&P 500 has risen 17% due to cooling inflation and the surge in interest in AI, while both 2-year and 10-year Treasury prices have fallen.
However, bond yields remain above 4%, while the equity rally has slowed down this month as investors fret that the Federal Reserve might hold interest rates higher for longer in its ongoing war on inflation.