The Equity Risk Premium Is Shrinking
S&P 500 earnings yield minus 10Y Treasury yield
The equity risk premium (ERP) — the excess return investors demand for holding stocks over bonds — has compressed to its lowest level since the early 2000s. With the 10Y above 4% and S&P 500 forward P/E at ~20x (5% earnings yield), the premium is approximately 1%.
What history says
Editorial commentary written by ALAN analysts. Figures cited below are analyst-authored context — they are not derived from the chart above and may reflect different windows or sources.
The long-term average ERP is approximately 3-4%. At 1%, stocks are priced for near-perfection. Any disappointment in earnings or rise in rates could produce a negative equity return.
A low ERP means expected returns are lower, not that returns will be negative. The S&P 500 has delivered positive returns in many periods with sub-2% ERPs. It just raises the probability of disappointing outcomes.
International developed (ERP ~4-5%) and emerging markets (ERP ~6-7%) offer higher risk premiums. The diversification argument is strongest when the US ERP is compressed.
A thin risk premium argues for tempering the return assumptions in your financial plan — retest savings rates and retirement dates against more modest equity outcomes — and for letting diversification toward higher-premium markets do the adjusting rather than a wholesale exit from stocks.