Negative equity risk premium highlights investor complacency

The current negative equity risk premium suggests markets may not be sufficiently compensating investors for today’s market and economic risks.

S&P 500 yield minus 10-year Treasury yield

• Stocks have enjoyed strong year to date returns driven by a healthy macro backdrop, near-historically low volatility and solid earnings growth, particularly among mega-cap technology firms. Enthusiasm for AI-driven investment stories has also pushed investor sentiment toward a notably more bullish tone.?
• Embedded within the positive sentiment has been a growing acceptance that the Fed may be able to achieve a soft economic landing as investors have largely shaken off a host of potential macro concerns.
• A higher-for-longer posture by the Fed in the face of lingering inflation concerns could still pressure stocks, as could a slowdown in the Magnificent 7 stocks, which have largely driven the S&P 500’s earnings growth, among other factors.

• Despite the potential risks, investors seem unphased by a potential market drawdown. Said another way, the equity risk premium, which compares equity yields to those available on risk-free Treasuries (and is a common way for analysts to decipher the level of excess return investors demand to assume equity market risk) has been negative for most of the past year.[1]
• U.S. equities could continue their march higher if the benign soft-landing scenario plays out as many suspect. Yet the current negative equity risk premium does not appear to be sufficiently compensating investors for the material risks still present within the economic and market backdrop.

Catch up on chart of the week.

[1] Standard & Poor's, Bloomberg Finance, L.P., as of May 30, 2024.

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