The Benefit of Owning Stocks Over Bonds Keeps Shrinking

livemint.com:

The extra reward for holding stocks instead of bonds has fallen to its lowest level in 20 years, threatening a recent hot streak for major indexes. One method for gauging the value of stocks is to compare their earnings yield—calculated by dividing a company’s expected earnings over the next year by its stock price—to the yield on government bonds, considered the closest thing to a risk-free return. The difference, sometimes called the equity-risk premium, shows how much investors are being compensated for the additional risk of owning stocks.

And right now, that isn’t much. The gap between the earnings yield of the S&P 500 and the yield on the 10-year U.S. government bond dropped to around 1.1 percentage point last week, its narrowest since 2002.

The spread to the yield on the 10-year Treasury inflation-protected security, seen by some analysts as the better benchmark because corporate earnings tend to adjust with inflation, has similarly fallen to its lowest level since 2003, at around 3.5 percentage points. The risk premium first started shrinking in the second half of last year. In that period, stocks stabilized from an early year selloff, even as bond yields kept climbing in response to the Federal Reserve raising interest rates to fight inflation.

This year, the premium has continued to dwindle for slightly different reasons: Bond yields haven’t risen as much, but stocks have taken flight—lifted by investors’ growing optimism about the economy. Whatever happens to change it, there is a consensus on Wall Street that the equity-risk premium can’t stay this low forever. For stock prices relative to earnings to be back to where they were at the start of the 2022 selloff “when interest rates are 2x, 3x higher than they