Traders’ Insight: Risk Premium Plummets

Investors have gotten more bullish in terms of sentiment as the market has moved higher this year. There are many ways to measure this sentiment. Most point towards the complete opposite of this time in 2022, when stocks were deeply negative.

One way to look at market sentiment is to look at how traders are considering risk. By and large, as markets have moved higher and investors have become more bullish, the premium for risk has dropped.

That suggests that traders aren’t only bullish. They also don’t see any big potential market downside anytime soon. For a bull market, that’s not a healthy sign. The market usually needs some skepticism to stay healthy as it continues higher.

Right now, the risk premium on the S&P 500 is at 2007 lows. Right now, there’s just a 1.1 percent differential in one key index. That’s the forward earnings yield on the stock market versus the 10-year Treasury yield.

The last time it was this low in 2007, markets had a major meltdown. By the time the market bottomed in 2009, there was nearly a 7 percent differential, and it was time to buy stocks.

While this is just one measure of market valuations right now, it’s a sign that the rally in the first half of the year may slow down as we enter the second half.

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