Equity Earnings Yield vs the 10-Year Treasury

What the spread measures

Start with the earnings yield. Take everything the corporate sector earned after tax in a quarter, annualise it, and divide by what the market says that sector is worth. The result is the return you would receive if profits stayed flat and were paid out in full: the inverse of a price-to-earnings ratio, expressed as a percentage so it can sit next to a bond yield on the same axis.

Then subtract the ten-year Treasury yield. What remains is the extra return equity offers over a risk-free asset, priced off realised profits rather than forecasts. When the number is positive, a dollar of corporate earnings buys more income than a dollar of Treasury principal. When it is negative, the opposite is true, and the buyer of equity is paying for growth that has not been earned yet.

The chart plots both legs rather than the difference alone, because the difference hides which side moved. The same gap can open because profits collapsed, because valuations re-rated, or because the bond yield jumped, and those are three different stories with three different implications.

Why this is not the S&P 500 version

The familiar chart on this subject divides the S&P 500 price by S&P 500 earnings. Both halves are licensed: the index level belongs to S&P Dow Jones Indices, and forward earnings estimates belong to the data providers that build them. The Shiller CAPE, the most quoted variant, is published under a non-commercial licence that rules out a paid product. None of it can be reproduced here.

So we use a wider base. The market value of nonfinancial corporate equity comes from the Federal Reserve's Financial Accounts, and after-tax profits with inventory valuation and capital consumption adjustments come from the Bureau of Economic Analysis. Both are public domain. The base includes listed and unlisted companies, which makes it broader than any index and slower to move.

The consequence is worth stating plainly: the level of this series is not comparable to a published S&P equity risk premium. Our earnings figure covers the whole nonfinancial sector, including firms with no traded equity, and our market value includes unlisted holdings. What does carry over is the shape. The turning points, the direction of travel and the position relative to the series' own history all survive the change of denominator. Read it as a regime indicator, not as a substitute quote.

The shape of the record

The series begins in the first quarter of 1962 at 2.2 points: an earnings yield of 6.1 percent against a ten-year yield of 3.9 percent. It reached its maximum of 8.4 points in the fourth quarter of 1978, when after-tax profits were running near 17 percent of market value while the bond yield sat at 8.6 percent. That combination is difficult to reconstruct today, and it captures what the late 1970s actually were: an equity market priced for oblivion while nominal profits kept pace with inflation.

Then the direction reversed. The Volcker tightening lifted the ten-year yield above 9 percent by 1987 while the earnings yield stayed near 4.7, producing the most negative reading on record, minus 4.9 points in the third quarter of 1987. The 2000 vintage was almost as extreme at minus 4.1, and for the same reason: an earnings yield below 2 percent against a six percent bond.

The long middle of the record is easy to misread. From the mid-1980s through the early 2000s the spread spent most of its time below zero, and equities delivered one of the best runs in market history. A negative spread was the normal condition of a high-rate world, not a warning. What changed after 2008 was the bond leg: quantitative easing held the ten-year yield under 2 percent for years, and the spread turned positive for two decades almost without a break. It peaked at 3.5 points in late 2011, when the earnings yield was 5.4 and the bond paid 1.9.

What the current negative reading means

The spread turned negative again in the first quarter of 2024, flickered positive once that summer, and has stayed below zero since. The cause is the bond leg, not a collapse in profits: after-tax corporate profits are near record highs in dollar terms, but the market value of the sector has risen faster, and the ten-year yield has climbed back above four percent. Two things happened at once, and the arithmetic of subtracting one from the other produced a negative number.

That matters because it removes the argument that carried equity allocation for fifteen years. Through the 2010s the case was mechanical: equities yielded more than bonds, so owning them was not a valuation stretch. That case is gone. It does not follow that equities are a sell; the spread says nothing about the growth rate of profits, and the corporate sector's earnings have grown through every quarter of the current inversion except two.

The honest reading is narrower. The margin of safety that existed when bonds paid 1.5 percent has been spent. Whether that resolves through falling equity prices, falling bond yields, or rising profits is not something this series can tell you.

Why it is not a timing tool

The spread was negative for most of the 1990s, and an investor who sold on that signal in 1996 missed four years of roughly twenty percent annual returns before the correction arrived. The 2000 reading was the most extreme in forty years, and it marked a peak within months, but the same reading had been flashing since 1997. A valuation ratio tells you the price of a stream of earnings; it does not tell you when the market will change its mind about that price.

What it does well is describe the trade-off. At a positive spread, equity is being paid for by current profits, and the risk is that profits fall. At a negative spread, the buyer is underwriting growth, and the risk is that growth disappoints while the bond coupon keeps arriving. Those are different bets, and knowing which one you are making is more useful than a forecast.

How we calculate it

The earnings yield is after-tax corporate profits with inventory valuation and capital consumption adjustments (NFCPATAX, billions of dollars at an annual rate) divided by the market value of nonfinancial corporate equity (NCBEILQ027S, millions of dollars), scaled to a common unit and expressed as a percentage. Both are quarterly. The bond leg is the ten-year constant-maturity yield.

The two inputs run on different clocks, so the comparison is made inside one quarter: quarterly market value and profits against the last Treasury observation of that same quarter. Pairing a June market value with an October yield would mix four months of rate movement into a valuation ratio and produce a change that no company earned.

The percentile is the share of quarters since 1962 that sit below the current reading. Because a lower spread means equity is more expensive relative to bonds, a low percentile is the stretched end of this series, and our market temperature score flips the sign accordingly.

Both inputs are US government releases in the public domain, distributed through FRED. The derived ratio is computed by us.

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