Treasury Yields Surpass S&P 500 as Yield Spread Reaches Historic Low
Government bonds are now offering better returns than stocks, indicating a significant shift in market dynamics.
The landscape of investment yields is experiencing a remarkable shift, as the yield spread between the S&P 500 and 10-year Treasury bonds has contracted to -1.5 percentage points. This marks the most significant decline since 2009, signaling a change in investor sentiment towards government bonds as a more favorable option than equities, according to insights from The Kobeissi Letter.
Understanding the Yield Spread
Typically, investors anticipate that stock investments should yield higher returns compared to safer government bonds, compensating them for increased risk. However, the current trend indicates that the yield spread could cross into negative territory for a third consecutive year, a trend not seen since 2002.
What is Yield Spread?
The yield spread is determined by taking the earnings yield of the S&P 500 — which is calculated by dividing the index's earnings by its price, effectively serving as the inverse of the price-to-earnings (P/E) ratio — and subtracting the yield of 10-year Treasuries from it. A positive yield spread typically rewards investors for choosing stocks, while a negative spread suggests that Treasuries are delivering higher returns.
Since 2022, this spread has narrowed dramatically by 440 basis points, equivalent to 4.4 percentage points. This steep decline represents the sharpest reduction observed over a five-year period since the 1970s, according to The Kobeissi Letter.
What’s Impacting Yields?
The yield spread narrows in situations where stock prices increase at a faster rate than corporate earnings or when bond yields climb. Recently, factors such as inflation driven by oil prices and substantial federal borrowing have attributed to rising Treasury yields. As of October 7, the yield on the 10-year Treasury bond reached approximately 5.36%, the highest experienced since 2002.
A yield spread of -1.5 percentage points implies that the earnings yield for equities is approximately 3.9%, indicating a P/E ratio of roughly 26 times historical earnings. Historically, instances of negative yield spreads have been associated with high risk and inflated market valuations.
What Does This Mean for Stocks?
While the negative yield spread raises concerns, it doesn’t automatically indicate that stock prices will decline. In 2025, Bloomberg columnist Nir Kaissar observed that a lack of yield spread did not reliably predict returns over short time frames, such as one to five years. However, there appeared to be a significant correlation of 0.51, indicating that lower yield spreads could predict poor long-term gains over a decade.
On the flip side, when examining forward earnings, the S&P 500 is currently valued at approximately 19 times projected profits, equivalent to an earnings yield of around 5.3%, which is generally in line with the yield of 10-year Treasuries.
As we head into the fourth quarter, The Kobeissi Letter anticipates a noteworthy period ahead for market dynamics. However, it's important to recognize that the yield spread alone cannot determine timing for potential shifts in the market landscape. Presently, the S&P 500 is reaching near-record levels, fueled by a narrow market breadth, leaving many investors reliant on stability in bond yields to maintain favorable valuations.
