Indicator Alert: Disappearing Equity Risk Premium

The U.S. 10Y yield has been soaring (from 4.18% to 4.61%) thus far in the month of September. It's not due to rising inflation expectations: The real 10Y yield on TIPS has also soared.

Why are real long-term rates rising? Sorry, it's not due to everyone betting on the nascent AI revolution bringing economic growth and returns on new tech. Rather, as I discussed in my podcast yesterday, it's due to everyone borrowing more and saving less. Boomers are cashing out and Millennials have little to cash back in; governments around the world (starting with the U.S.) are running massive deficits as a share of GDP; and, oh btw, Chairman Powell continues to sell roughly $100 billion in bonds from the Fed's balance sheet every month.

With nominal and real rates so much higher and with the S&P 500 (until very recently) riding high, the equity premium is slamming shut. Thirteen months ago, the forward 12-month earnings yield on the S&P exceeded the 10Y yield by just under 3.00%. Today, it only exceeds the 10Y yield by less than 0.50%. That's the lowest equity premium since June 2002.

Implications? Investors are finally awakening to the vast shift in the differential returns on equities v bonds. This awakening will continue to feed the current selloff in equities. Global investors are shifting instead to Treasuries—both long-term (always a good pre-recession bet) and short-term (a liquid safe haven, but now with an excellent yield). The overall yield curve may stop rising, or rise more slowly, but the overall shape of the current yield-curve inversion may not change much.