Record Earnings Drive Stocks While Bonds Compete for Cash
Stocks are reaching all-time highs, buoyed by an exceptional earnings season, yet the bond market poses a serious challenge for investor dollars.
The S&P 500 (^GSPC) is experiencing one of its most robust earnings seasons seen in decades, with profit growth on the rise. Remarkably, more companies are exceeding earnings expectations, prompting analysts to revise their future forecasts upward rather than downward.
The underlying strength in profits supports the recent stock market highs. However, the bond market may complicate this upward trajectory.
Recent analysis comparing the S&P 500’s earnings yield with the yield on 10-year Treasury bonds (^TNX) highlights this competitive landscape. The earnings yield reflects the returns investors receive from stocks, inversely related to the well-known price-to-earnings (P/E) ratio. By subtracting the yield from government debt, a clearer picture emerges of the additional returns investors are seeking from equities versus Treasuries.
Currently, the S&P 500’s earnings yield stands at approximately 3.4%, while 10-year Treasury yields hover around 4.5%. This creates a negative gap of about 110 basis points—the widest deficit since 2003. This gap serves as a rough gauge of the equity risk premium, indicating the extra returns investors anticipate for holding stocks over safer government securities.
This dynamic does not necessarily imply that stocks must decline; rather, it showcases a shift in post-financial crisis valuations. Historically low long-term bond yields made expensive equities easier to justify. Now, with rising Treasury rates offering viable alternatives, the investment landscape is changing.
It’s essential to consider forward earnings as well. By transitioning to the forward P/E ratio—reflecting analyst projections for the upcoming year—the outlook shifts slightly. When using forward earnings, the S&P 500’s earnings yield is around 4.5%, marginally exceeding the 10-year yield. Thus, while the realised earnings data suggests bonds hold the advantage, forward projections indicate that stocks retain a slight edge—provided earnings continue to meet expectations.
However, should the 10-year yield surpass 4.6% and continue to rise—something it has been signalling for over a year—the investment landscape could tilt significantly in favour of bonds, reducing the attractiveness of stocks.
In this context, the current surge in earnings is critical. Investors are not dismissing the bond market’s implications but rather betting on the premise that forthcoming profits will outpace these warnings.
This period of exceptional earnings is pivotal, and its persistence is crucial for maintaining the current bullish sentiment in equities.
Jared Blikre serves as the global markets and data editor for Yahoo Finance. For insights, follow him on X at @SPYJared or reach out at jaredblikre@yahooinc.com.
