MW Stocks are losing their edge over bonds, in an ominous sign for the market
By Christine Idzelis
The equity risk premium has been shrinking, making some on Wall Street nervous
The S&P 500 was attempting a fresh record on Wednesday.
The extra return that investors receive for the additional risk of owning stocks over bonds has been fading, and that is making some on Wall Street nervous that investors might be too complacent about the stock market's recent rally.
The S&P 500 has continued to trade at or near record highs, even as bond yields have crept higher on inflation fears during the Iran war. Stocks and Treasury bonds were rallying on Wednesday, with bond yields - which move inversely to prices - moving lower as oil prices retreated.
Still, a closely followed market gauge is pointing to a notably low premium for stocks relative to bonds. The so-called equity risk premium, or the difference between the forward earnings yield for the S&P 500 and the yield on the 10-year Treasury note, is on the cusp of turning negative for what would be the first time since late 2024 or early 2025, according to Michael Darda, chief economist and market strategist at Roth Capital Partners.
Roth Capital, Workspace, Bloomberg
The fact that the ERP is currently at a below-average level suggests investors could see lower returns ahead for U.S. stocks, according to Gina Martin Adams, chief market strategist for HB Wealth. It is worth watching as a potential "trip wire" for stocks, because if the ERP crosses into negative territory, the market could see stress, she said in a phone interview.
Darda pointed out that the last time this happened, the S&P 500 skittered to the edge of bear-market territory shortly afterward. That steep drop for the index followed President Donald Trump's tariff shock last year, he noted.
But for now, Martin Adams said, the low ERP isn't necessarily troubling. "This one indicator would say, don't get too panicked, but definitely expect a little less," she said.
A negative reading on the ERP has shown up ahead of several notable market crashes. These include Black Monday in 1987, as well as during the global bond crisis in 1994 and shortly before the peak of the dot-com bubble, according to Martin Adams. That doesn't mean something similar will happen this time around, but she did note the ERP was approaching a low level that historically has left equity returns struggling to crack double digits.
"We are in a zone in which your average annualized returns are a little bit lower than they have been in the recent past, because the equity risk premium is low," Martin Adams told MarketWatch. "That certainly makes investors nervous, but it may stay low as long as inflation is the predominant risk to the market outlook."
Brad Conger, chief investment officer at Hirtle & Co., said in an interview that he was concerned about the low premium investors are getting to take risk in equities relative to bonds.
He recalled seeing the ERP go to zero amid the "tremendous excitement over a technological revolution" during the dot-com era, before that bubble burst.
"I just think the market is pinning a lot of its expectations on a very narrow set of companies continuing to outperform based on what I would say is a very narrow thesis" relating to the buildout of artificial intelligence, he said. "The payoff from the services that are associated with AI, they don't seem to justify the magnitude of the investments" in the technology.
Blame bonds for low ERP
While investors may see a low ERP as a risk to stocks, its compression is the result of climbing bond yields, according to Martin Adams. Stocks have been getting more expensive on a relative basis "because bonds have been getting cheaper," she said.
Bond prices fall when yields climb. So the inflationary pressures in the wake of surging in oil prices (CL00) during the Iran war have driven Treasury bond yields BX:TMUBMUSD10Y BX:TMUBMUSD02 higher this year, eroding their value.
Check out: This chart is a flashing warning sign that the Fed might yet rattle the markets with rate hikes by year-end
Meanwhile, the valuation of the S&P 500 based on its forward price-to-earnings ratio has recently remained below its 2025 peak, according to Martin Adams.
The stock market has appeared less worried than the bond market about inflation. But equities are more likely to struggle when stock-market investors become fearful about risks to growth, said Martin Adams.
And at least for now, company earnings have stoked optimism that the bull market can continue.
There's no recession in sight, Michael Rosen, chief investment officer of Angeles Investments, said in an interview. Tuesday. "It's profits that drive equity markets," he said, and "profits have been strong."
"We have heard that the U.S. stock market has been overvalued for the last 10 years, and yet we're at an all-time high," Rosen said. "While valuations have been high over the past decade, profit growth has been exceptionally strong."
The U.S. stock market was rising Wednesday morning, with the S&P 500, Dow Jones Industrial Average DJIA and Nasdaq composite COMP all up, according to FactSet data, at last check. The S&P 500 was trading in record territory after closing at an all-time high on Tuesday.
-Christine Idzelis
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(END) Dow Jones Newswires
May 06, 2026 10:38 ET (14:38 GMT)
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