Surging US Treasury yields are making bonds nearly as attractive as stocks, with the 10-year Treasury yield reaching 5.167% and the 30-year yield exceeding the S&P 500's earnings yield by almost 0.5 percentage points. This has caused the yield gap, which measures the extra return investors get for taking on equity risk over bonds, to shrink to just 3 basis points, its lowest since 2004, according to Hana Securities. The compression is primarily driven by a rapid rise in Treasury yields, with the 10-year yield increasing 41 basis points in September alone.
This narrowing yield gap poses a significant challenge to equity valuations. When "risk-free" Treasuries offer yields above 5%, investors demand higher expected returns from stocks. To meet this demand, corporate earnings would need to grow faster, or share prices would have to fall to reduce price-to-earnings (P/E) ratios. The S&P 500's 12-month forward P/E ratio implies an earnings yield of 5.19%, making the investment appeal of stocks over bonds "on the verge of disappearing," according to Lee Jae-man, a researcher at Hana Securities.
While some analysts note that strong corporate earnings growth has helped stocks so far this year, with the S&P 500 gaining nearly 13% even as its P/E ratio declined from 22x to 19x, the sustained rise in bond yields could prompt a significant rebalancing. JPMorgan Chase & Co. projects that real-money portfolios, including sovereign wealth and pension funds, might shift as much as $150 billion out of stocks and into bonds to meet allocation targets. This potential rebalancing could lead to a 3% to 5% correction in global equities, with institutions like Japan's Government Pension Investment Fund potentially selling $37 billion in equities and the Norwegian oil fund moving $18 billion from stocks to bonds.
