The disparity between U.S. stock and bond markets has raised concerns among analysts regarding the U.S. equity risk premium (ERP). As the ERP approaches historically low levels—some suggest it may be the lowest in 25 years—investors are questioning whether equities are becoming overvalued when compared to Treasuries. The ERP, calculated as the difference between the S&P 500 earnings yield and the 10-year Treasury yield, typically offers a premium for equities over “risk-free” government debt. In normal circumstances, this premium remains positive.

However, current conditions are far from typical. As the Federal Reserve begins to reduce interest rates, long-term bond yields are surging, influenced by ongoing inflation concerns and rising U.S. debt levels. Meanwhile, enthusiasm surrounding artificial intelligence (AI) and the narrative of the “U.S. exceptionalism”—largely driven by a select group of Mega Cap tech companies—has inflated stock valuations to unprecedented heights, exacerbating the imbalance.

Consequently, the ERP has contracted and sometimes turned negative. Should the 10-year Treasury yield continue to climb, the ERP could shrink even further, suggesting that stocks may appear increasingly costly relative to bonds.

Does this indicate it’s time for a portfolio shift away from stocks and toward Treasuries? While high stock valuations are concerning, it’s crucial to consider historical trends and macroeconomic factors before making any decisions. Utilize the Financial Growth API for monitoring shifts in valuations and financial performance across various sectors.