U.S. Treasury Yields Climb Steadily, Sounding Alarm Bells for U.S. Stock Valuations

Barron's reported on Monday (the 20th) that U.S. equities are recovering from last week's technology-driven sell-off, but warning signals from the bond market remain unresolved. As long-term U.S. Treasury yields climb, the S&P 500 index's earnings yield has failed to rise in tandem, causing the excess return offered by stocks over bonds to continue shrinking—highlighting that U.S. stock valuations are stretched.

The S&P 500's latest earnings yield stands at 4.95%, below the 30-year U.S. Treasury yield of 5.0685%. The difference—the equity risk premium—fell to negative 0.1185 percentage points last Friday, meaning investors are bearing stock market volatility without receiving an expected return higher than that of long-term Treasuries.

Historically, since July 2007, fewer than 6.4% of trading days have seen a lower risk premium.

When compared to the 10-year Treasury yield, the S&P 500's equity risk premium remains positive but narrow at just 0.2654 percentage points. Fewer than 5% of trading days during the same period have seen lower levels.

The shrinking equity risk premium reflects both expensive U.S. stock prices and the rapid rise in real U.S. Treasury yields.

As of last Thursday, the 30-year Treasury's real yield rose to 2.91%, the highest since 2008. The 10-year real yield climbed to 2.35%, the highest since the end of 2023.

James Reilly, Senior Market Economist at Capital Economics, noted that even the 2-year Treasury's real yield has surged to its highest level since mid-2024, with the past two months' gains among the largest in decades.

The rise in real Treasury yields partly reflects the expanding size of U.S. debt, raising expectations that the Treasury may need to issue more bonds to fund future obligations. Additionally, concerns that inflation remains uncontrolled—potentially prompting the Federal Reserve to raise rates later this year or next—have pushed up the yields investors demand.

David Rosenberg, economist at Rosenberg Research, commented that if corporate earnings are used without adjustment, the S&P 500's earnings yield is around 4.3%. Compared to the 30-year Treasury's real yield, the current equity risk premium is now "razor-thin" by historical standards.

With the S&P 500 repeatedly hitting record highs this year, already elevated valuations have faced scrutiny over their sustainability. Now, with real yields climbing further, bonds are becoming relatively more attractive than stocks, increasing the risk of a valuation correction in U.S. equities.