Why US Stocks Are Trading at a Premium to Bonds—and What It Means for Investors

In mid-June 2025, US equity markets have staged a remarkable rebound, bringing the S&P 500 within 2% of its all-time high. Yet behind the headlines of tariff-fueled rallies and blockbuster corporate earnings lies a critical signal for investors: stocks are unusually expensive relative to bonds. Measured by the equity risk premium—the gap between the S&P 500’s earnings yield and the 10-year Treasury yield—valuations now sit near their lowest levels seen since 2002.

This dynamic has sparked debate among market observers. On one side, proponents of equities point to robust economic data, steady corporate profits and the prospect of easing trade tensions. On the other, skeptics note that bonds may soon deliver comparable returns with far less volatility. In this analysis, we break down the drivers behind the narrow equity risk premium, review historical precedents and outline strategies for navigating a market where stocks look pricey compared to fixed income.

Understanding the Equity Risk Premium

The equity risk premium (ERP) is calculated by subtracting the S&P 500’s earnings yield (the inverse of the price-to-earnings ratio) from the yield on 10-year US Treasuries. When this gap narrows, stocks become relatively more costly versus government bonds. As of June 12, 2025, Bloomberg Intelligence data shows the ERP hovering near multi-decade lows—suggesting investors are accepting slimmer compensation for the additional risk of equities.

• What it measures: ERP quantifies the extra return investors demand for holding stocks instead of “risk-free” Treasuries.
• Why it matters: A low ERP historically precedes below-average equity returns, as the cushion against market downturns erodes.

Historical Performance in Low-Premium Regimes

Data compiled by CFRA highlights two key episodes when the ERP remained subdued:

1. 1980–2002: Despite a protracted period of low or negative ERP, the S&P 500 delivered an impressive 10% annualized return, reflecting broad economic growth and favorable demographic trends.
2. 1968–1973: Stocks underperformed, averaging just 1.1% per year amid inflationary pressures and tightening monetary policy.

More recently, when ERP has dipped to current levels, the S&P 500’s subsequent 12-month return has averaged only 2.5%, versus a long-term norm of about 8.5%. This divergence underscores the risk that an equity-heavy portfolio may struggle if bond yields hold firm.

Why Bond Yields Are Rising

A confluence of factors has driven Treasury yields toward multi-year highs:

• Fiscal deficits: Mounting US government borrowing has increased supply of Treasuries, pushing yields upward.
• Inflation trends: Although headline inflation has cooled in recent months, core CPI readings remain sticky, keeping investors wary of premature rate cuts.
• Fed policy outlook: Markets are split on whether the Federal Reserve will pivot to easing later this year—some data points to weaker growth, while robust employment metrics suggest rates may stay elevated.

With 10-year yields offering north of 4.5% in mid-June, bonds are increasingly attractive for income-seeking investors, especially when accounting for capital preservation.

The Case for Caution in Equities

Veteran strategists warn that stocks may have limited upside from here:

“Whenever the equity risk premium sinks this low, it signals that stocks are getting expensive,” says Timothy Chubb, CIO at Girard. “After a massive rally, we could see a pullback as bond yields remain stubbornly high.”

In addition, trading volumes have flattened, with the S&P 500 moving less than 0.6% on 10 of the past 11 sessions—the longest such dry spell since December. This lackluster activity suggests investors are waiting for fresh catalysts before adding equity risk.

Balancing Portfolios in a Premium Squeeze

Given the valuation gap, a balanced approach can help manage downside risk while capturing growth:

• Tilt to quality: Favor blue-chip and dividend-paying stocks that offer more predictable cash flows.
• Laddered bond portfolios: Build a staggered maturity structure to lock in higher yields and mitigate interest-rate risk.
• Alternative income streams: Consider real estate investment trusts (REITs) or infrastructure funds for additional yield with inflation protection.

Seasoned investors also recommend harvesting gains from high-flyers and redeploying capital into under-owned sectors that may better weather rate volatility.

What Comes Next?

Key data points to watch in the coming months include:

• Inflation reports: CPI and PCE readings will guide Fed expectations.
• Treasury auctions: Strong or weak demand at Treasury sales could signal future yield trends.
• Corporate earnings: Any signs of margin compression may rein in lofty equity multiples.

Ultimately, while equities remain a vital growth engine, the current premium squeeze underscores the importance of disciplined risk management. As bonds close the return gap, investors who rebalance thoughtfully may preserve capital and still participate in market upside.