The S&P 500 risk premium shrinks to lowest level since 2000. Is the market too risky?

As highlighted by market analysts on November 14, the S&P 500 equity risk premium has significantly shrunk, reaching near-zero lows. This new level is the lowest since 2000 when the value went negative. The risk premium plunge is causing speculation in financial markets, with many assuming that the worst is YET to come. 

An equity risk premium is the extra money investors expect to gain from trading higher-risk assets such as stocks instead of settling on risk-free assets like government bonds. Hence, a decline in risk premium means that investors will not earn as much as they expected from stocks. 

The S&P 500 is the constant used to measure the expected equity risk premium in the stock market, measured against the 10-year U.S. Treasuries.

Gresham Partners, an investment planning company, confirmed earlier this year that the equity risk premium has been steadily declining since the last global financial crisis in 2008. The firm confirmed that the current decline could indicate a growing interest in bonds rather than stocks. 

The current bond yield is not far off what investors can get from stocks, making stocks less appealing. Bond yields have notably been rising since the Fed rate cut on September 18, also triggering a rise in mortgage rates in the country. The Trump victory in the November 5 elections has also triggered a continued rise in bond yield interest rates. 

Stocks have been riding the Trump victory wave, performing better since last week. U.S. equity indices, including the S&P 500, Dow Jones, and Nasdaq composite index, also closed on a high last week compared to the week before.

Some economists still speculate the market may drop after the Trump frenzy ends. John Higgins, a chief economist at Capital Economics, especially expressed worry about the President-elect’s policies, which could create risks for the S&P 500. 

The risk premium plunge may be due to an increase in bond yield interest rates

With this move in bond yields, we are now just 10 basis points away from the Equity Risk Premium shifting negative. Ergo, investors are willing to pay to take on equity risk instead of getting paid to. pic.twitter.com/U7uzIOOuU1

— David Rosenberg (@EconguyRosie) November 12, 2024

The founder and president of Rosenberg Research and Associates Inc., David Rosenberg, revealed that the U.S. equity risk premium is 10 basis points away from going negative. The economist also touched on the influence the current movement of bond yields might have on the plunging equity risk premium. 

Other analysts agree with him, mentioning that the skyrocketing bond yield interest rates have the opposite effect on the risk market’s unpredictability. 

Some economists still think it would be unwise for investors to dispose of their stocks. Asset management firm Alliance Bernstein gave an example of the equity risk premium lingering around 1% between 1983 and 2008. The firm revealed that the S&P 500 still managed over 10% annualized returns during the period. 

Economists speculate Trump’s policies could increase S&P 500 earnings

Wall Street asset management company Goldman Sachs recently speculated that Trump’s tax policies could improve S&P 500 earnings. The investment bank argued the possibility of a rise in earnings by 20% over the next 2 years, expecting an 11% rise in 2025 and a 7% increase in 2026. 

The bank highlighted the index’s rally to new highs after Trump’s victory. Goldman Sachs also pointed out the uncertainty surrounding the recent elections before the definite results came out. The investment firm revealed that since then, investors have been engaging with successful stocks since 2016. 

David Kostin, an executive at Goldman Sachs, discussed the S&P 500 index’s historic performances. According to Kostin, the current market stability and the forecasted Fed rate cuts up to mid-next year will create a healthy environment for stocks.