The equity risk premium is negative… but is this the whole story?… the key missing ingredient that changes everything… how Louis Navellier is outperforming
We have a problem…
On the surface, the market appears to be in good shape. The S&P is up almost 16% this year after back-to-back 20%+ gains the previous two years.
It’s easy to feel bullish when the returns are that strong.
But a warning sign has started to flash, and we need to look directly at it…
On a risk-adjusted basis, U.S. stocks are now paying investors zero extra return above bonds.
That’s what one popular market metric is screaming – and it’s why a growing number of analysts are sounding the alarm that stocks may be priced for perfection.
That is often a precursor to dashed expectations.
Let’s unpack this.
On the one hand, we don’t want to ignore another sign of market risk. On the other hand, this may be more nuanced than the headline suggests, so we don’t overreact and prematurely exit the market.
What is the negative Equity Risk Premium (ERP) really telling us?
To make sure we’re all on the same page, the ERP is a calculation meant to answer a simple question…
How much extra return do stocks offer compared to “risk-free” Treasury bonds?
After all, stocks are far riskier than bonds. If you hold a Treasury bond to maturity – assuming the government doesn’t collapse – you’ll receive interest payments plus the return of your principal.
Stocks offer no such guarantee. With unfortunate timing, you could be down 20% by lunch.
So, historically, stock investors have demanded an added return on top of what they can get from “risk-free” bonds to compensate them.
In its most commonly cited form (often called the Fed Model), ERP is calculated as:
S&P 500 earnings yield – 10-year Treasury yield
With this framework in mind, let’s turn to Bloomberg:
With stocks pressing to new highs, the equity risk premium has all but disappeared, hinting that large- and small-cap stocks are no more compelling than Treasuries or corporate bonds.
As you can see below, today’s ERP is now negative – and lower than at any time since shortly after 2000.
Historically, this setup is rare and often associated with overvalued markets.
A quick look back at what happened when the ERP went negative
We saw loosely similar readings in the late 1990s during the dot-com bubble, and then briefly in 2018 before a sharp fourth-quarter selloff.
In 2000, stocks were trading at nosebleed valuations. The S&P 500’s P/E ratio had soared above 30, and earnings yields couldn’t keep pace with rising Treasury yields.
When the bubble finally burst, the S&P 500 fell roughly 49% from peak to trough over the next two-and-a-half years.
The 2018 episode was less dramatic but still worth our attention.
After a strong run-up through September, compressed risk premiums coincided with concerns about Fed tightening and slowing growth. The S&P 500 dropped nearly 20% in the final quarter before recovering in 2019.
Both cases share a common thread…
When stocks offer little to no extra compensation for their inherent risk, the market becomes vulnerable to disappointment.
That’s why you’ll hear the bearish conclusion framed like, “on a risk-adjusted basis, stocks offer zero return.”
Now, if that were 100% true and the whole story, this is one of the least attractive moments to own stocks in years. Taking profits off the table would be a no-brainer move.
But let’s be thoughtful investors and ask a follow-up question…
Does the ERP really capture what stocks are worth today?
The ERP calculation starts with the S&P 500 earnings yield.
If you’re less familiar with it, the earnings yield shows us the inverse of the P/E Ratio – it tells us what percentage of our investment is returned as profit each year.
The problem is that stocks are not bonds. We don’t just pocket those earnings and walk away. So, many investors prefer a different calculation:
Expected return = earnings yield + sustainable earnings growth
Let’s put some real numbers around this.
As I write on Monday morning, according to Multpl.com, the S&P 500 trades at a P/E ratio of 30.88. To convert this into an earnings yield, we divide 1 by the P/E ratio, which gives us about 3.2%.
Next, the 10-year Treasury yield is roughly 4.16% – meaning an investor can lock in a higher yield from government bonds than from the market’s current earnings power alone.
This is why the Fed Model ERP is flashing that “negative” warning sign.
But stopping here ignores something critical: stocks can grow.
So, what earnings growth rate do we include?
There’s no universally agreed-upon rate. But historically, it tends to run around 4% – 6% for U.S. companies. Let’s make it simple and say “5%.”
So, with an earnings yield of 3.2% and a growth rate of 5%, our expected stock return is 8.2%. After subtracting the 10-year Treasury yield of 4.16%, the ERP is now…
About 4%.
Not negative at all.
But what if earnings growth is even better?
According to legendary investor Louis Navellier, we’re not operating in an “average” earnings environment today.
From Louis’ latest issue of Accelerated Profits:
The S&P 500 achieved 13.4% average earnings growth in the third quarter – that’s the fourth consecutive quarter of double-digit earnings growth.
Now, that’s great, but what we care about is future earnings growth. Fortunately, Louis expects more double-digit gains to come:
Looking forward, FactSet anticipates that the S&P 500 will achieve 7.7% average earnings growth in the fourth quarter.
Positive analyst revisions typically precede future earnings surprises, so the S&P 500 will likely achieve double-digit earnings growth for the fourth quarter, too.
In other words, we remain in the strongest earnings environment in years!
Returning to our prior math, if we swap out average 5% earnings growth for, let’s call it, 10% growth (reasonable for the kind of stock Louis recommends in Accelerated Profits), then suddenly, the ERP for quality stocks isn’t just positive, it’s about 9%.
To be clear, Louis’ fundamentally superior stocks are not a proxy for the entire market.
In fact, Louis has been explicit about this point. Back to his Accelerated Profits issue:
The stock market’s breadth and power grew more narrow during the third-quarter earnings season.
I expect more F-rated stocks in my Stock Grader system to sink in the upcoming months – and more of the fundamentally superior stocks like our Accelerated Profits stocks to rise to the top.
This distinction matters.
Narrowing breadth means fewer stocks are doing the heavy lifting – and more of the market is being left behind. This is exactly the kind of late-cycle behavior we tend to see as bull markets mature.
And it brings us back to the bigger picture.
So, what is the ERP really signaling today?
When we step back, the big picture comes into better view…
The headline ERP likely overstates how unattractive stocks are…but the super-compressed nature of the risk premium is still telling us something important.
The margin for error in today’s market is shrinking.
Now, this doesn’t mean stocks are about to crash. But it does mean that sloppy investing is far less likely to be forgiven.
This dovetails with what we’ve been tracking on our Crazy Map.
As a quick reminder, back in September, we introduced our “Crazy Map” – a set of late-cycle signals that often line the path to a bull market’s eventual peak. The takeaway was clear: we were no longer in a pure “green light” market.
Speculation was rising, leverage was creeping higher, and story-driven stocks were regaining traction. It all pointed toward “caution” – not full red, but clearly yellow.
A compressed equity risk premium fits that diagnosis.
It’s another data point suggesting the market is later in the cycle than earlier. It’s a reminder that conditions today reward discipline and punish complacency.
However, and this is crucial, it’s not a sell signal in isolation.
Our macro expert Eric Fry of Fry’s Investment Report often makes this point: late-stage bull markets can run far longer than anyone expects. The final leg higher can be explosive, delivering some of the best gains of the entire cycle.
The key is staying invested in the right stocks – those with the fundamentals to justify their valuations and the earnings power to continue attracting capital.
This is why Eric has urged investors to take profits on overextended tech names, redirecting capital into earlier-stage, undervalued companies that can benefit from the AI wave without excessive valuation risk.
He recently released a “Sell This, Buy That” presentation that identifies several high-conviction swaps for navigating this environment (he gives away the names of three of his top picks for free).
And brings us to our action step today…
So, what should investors do right now?
It’s not “get out” – especially not when earnings growth remains strong and momentum is still on the bulls’ side.
But the negative ERP is saying, “Be selective.”
And that means taking a hard look at your portfolio. You want to weed out:
- Hope-driven stories
- Crowded trades with no margin for error
- Stocks that need “perfect conditions” to justify their prices
Instead, make sure you’re holding:
- Fundamental excellence
- Earnings momentum
- Companies that consistently beat expectations
I should note that this is why Louis’ portfolios keep outperforming in environments like this – they’re anchored in financial strength, earnings acceleration, and quality.
In fact, with earnings season now behind us, here’s Louis with how his picks performed:
Our Accelerated Profits stocks also had a phenomenal earnings announcement season.
We had 42 Buy List companies release quarterly results, with 31 beating analysts’ earnings estimates.
Only seven companies missed analysts’ earnings expectations. Our average earnings surprise was a whopping 39%.
That performance isn’t an accident. It’s the result of Louis’ quantitative system that identifies companies with earnings momentum before the Street catches on.
You can learn more about joining Louis in Accelerated Profits here.
Coming full circle – does the negative ERP mean it’s time to sell stocks?
No.
But neither is it something to brush off. It’s less “red flag” and more “caution signal.”
So, tighten your discipline… focus on fundamentals… and own the kinds of stocks that can still deliver outsized rewards – even late in the game.
Before we sign off…
Today is the final day to access the free replay of last week’s American Dream 2.0 Summit where Louis, Eric, and Luke Lango released their latest Power Portfolio.
As a quick reminder, the Power Portfolio happens once a year when our three experts collaborate to identify a small group of high-conviction stocks, best positioned to outperform over the coming 12 months. Last year’s batch delivered a 32% return, nearly triple the Dow and more than double the S&P 500 over the same stretch.
This year, our experts have flagged a handful of elite stocks that they believe sit at critical inflection points in AI, automation, and America’s industrial rebuild. And earlier today, they released their final Power Portfolio selection. It’s a stock they’ve flagged as having the earnings strength, valuation support, and strategic exposure to outperform even as the market becomes more selective.
By the way, tomorrow, Louis, Eric, and Luke will hold a live Analyst Roundtable for Power Portfolio subscribers. They’ll walk through their new basket of stocks, how they’re thinking about today’s market, and how AI and automation are reshaping opportunities at a scale we’ve never seen before.
You can watch last week’s free replay right here. But this is it – last call – the research goes offline tonight.
Have a good evening,
Jeff Remsburg
