Rare in 25 years! The 10-year US Treasury yield surpasses the S&P 500 earnings yield.

The yield spread between bonds and stocks has reversed to its most favorable level for bonds in 25 years, a structural shift that is forcing investors to re-examine their asset allocation logic.

The 10-year U.S. Treasury yield has broken through 5%, making bonds as attractive relative to stocks at their highest level in about 25 years. Stock earnings yields, measured by the inverse of the S&P 500's price-to-earnings ratio, are currently lower than the 10-year U.S. Treasury yield, meaning that bonds are exerting significant downward pressure on stocks in terms of returns.

This pattern poses potential downward pressure on the stock market. Yale economist Robert Shiller's cyclically adjusted excess CAPE yield model suggests that the S&P 500 may outperform bonds by only about 1% annually over the next decade. Investors' tolerance for errors in their expectations of corporate earnings has narrowed significantly.

Long-term bond investors suffered heavy losses, and signs of a bursting bubble were evident.

High yields are, to some extent, a reflection of economic resilience – US stocks are near historical highs, the US economy is performing better than expected, and the impact of rising long-term interest rates has not yet been fully reflected at the macro level.

However, those who first bet on long-term bonds are the ones who are under pressure. Taking the TLT ETF, which tracks U.S. Treasury bonds with maturities of 20 years or more, as an example, these investors have already suffered significant losses.

Looking back, the bond bull market fueled by a decade of low inflation and government intervention after the crisis, as well as the price surge during the pandemic, in hindsight, exhibited characteristics of an asset bubble.

Market dynamics suggest that a bursting bubble often signals a buying opportunity. The current yield on 10-year Treasury bonds, above 5%, is at a level rarely seen in decades, indicating a substantial reassessment of the investment value of bonds.

The inverted yield curve logic has ended, and the 20-year paradigm of stocks outperforming bonds has been broken.

The traditional market consensus held that stocks, due to their growth potential, should enjoy a valuation premium relative to bonds, meaning that stock earnings yields were naturally lower than bond yields.

However, for about two decades after the global financial crisis, this logic was completely overturned—stock earnings yields consistently exceeded bond yields, making stocks the undisputed superior asset.

Today, this pattern has reversed again. Comparing stock earnings yields with the yield on 10-year U.S. Treasury bonds, the relative attractiveness of bonds has returned to levels seen approximately 25 years ago.

This means that even though the stock market's price-to-earnings ratio has contracted to absorb higher bond yields, the stock market outlook still faces some pressure.

The Shiller model raises concerns, but its historical limitations also warrant attention.

Robert Shiller's excess CAPE yield metric predicts excess returns for stocks over the next ten years by comparing the cyclically adjusted real earnings yield with the 10-year Treasury yield.

Historical data shows that this indicator has significant predictive power for stock excess returns over the next ten years, while the current reading only suggests that the S&P 500 will outperform bonds by about 1% per year over the next ten years.

However, the model's predictive accuracy has declined in recent years—the actual stock market performance has far exceeded its expectations, which may be related to the continued policy intervention in the market.

Nevertheless, the core message remains clear: the substitution value of bonds is at its highest level in a generation. Against this backdrop, investors need to scrutinize S&P 500 earnings growth forecasts with more stringent standards, because the bond market will no longer offer any buffer should corporate profits fall short of expectations.

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