Valuations Are a Vibe Until the Discount Rate Hits
The S&P is at 21.6x. The ERP is falling. Earnings are softening. The music is still playing but the lights just flickered.
The S&P 500 now trades at 21.6x forward earnings, a level that made sense when real rates were negative and the Fed was stuffing liquidity into every crack in the system. That world is gone.
We now have sticky inflation, a term structure that won’t lie flat, and a bond market that’s quietly reasserting its dominance. Meanwhile, the implied equity risk premium (ERP) — the reward for taking equity risk over Treasuries — is disappearing.
This isn’t a bubble pop. It’s a pressure build and valuations are the surface tension.
📉 The ERP Is Telling You to Pay Attention
Here’s where the market stood on June 1, 2025, using various ERP methodologies:
Trailing 12-month (adj. payout): 4.02% (down from 4.41% in May)
Trailing 12-month cash yield ERP: 4.23%
Net cash yield ERP: 3.96%
Normalized earnings & payout ERP: 3.73%
10-year average CF yield ERP: 5.43%
This is not pricing in recession risk. It’s barely pricing-in noise.
All of this is happening while the 10Y Treasury yield hovers north of 4.3%, compressing the risk buffer further. You’re getting equity-like volatility for less and less premium — and the market is acting like that’s a reasonable trade.
🧠 Valuation Expansion, Not Earnings, Is Driving the Rally
Let’s be clear: this isn’t an earnings story.
According to FactSet (June 13):
Q2 earnings growth estimate: +4.9% YoY
CY 2025 forecast: +9.0%
Forward EPS: up just 0.6% since March 31
But the S&P 500 Net Total Return Index is +9.68% this quarter, and +4.89% YTD as of June 26, 2025.
This rally is built on expanding P/Es — not fundamentals.
Sector Skew: Who’s Really Driving the Multiple?
The S&P 500 forward multiple isn't just high — it’s being warped:
Information Technology: +6.66%, 29.27x
Consumer Discretionary: -3.39% , 27.8x
Health Care -2.62% , 23.81x
Industrials: +11.40% , 23.7x
Consumer Staples: 4.62% , 22.3x
Materials: +4.86% , 21.95x
Financials: +7.47% , 12.41x
Energy: -0.28% , 12.14x
Large Cap Tech and Consumer names are doing all the heavy lifting, while defensive and value sectors lag — not because of poor earnings, but because the market is chasing long duration again, just as duration gets repriced.
When cash isn’t just safe but yielding 5%, these high-multiple names become a tougher sell — unless you believe in immaculate disinflation, sustained margin growth, and no surprises from the Fed.
🦉 Imperfect Hedge View
This is not 2021. The macro backdrop is different. The fiscal trajectory is worse and the real rate regime has changed.
This is the part of the cycle where the index stops climbing on earnings and starts relying on belief. That’s fine until belief is no longer enough.
Yet the ERP is compressing, valuations are expanding, and everyone’s still crowding into the same trades.
When your risk premium falls below 4%, and your long bond yields 4.3%, you’re not being paid to be long..... You’re volunteering.