Are US Equities in a Bubble? Not Quite - But Warning Lights Are Flashing

At Sismo, we’ve been tracking the median Cost of Equity for the Russell 1000 since 2007 using a proprietary model applied stock by stock.

Our Cost of Equity combines two price-anchored components:

• an earnings-yield component, the primary driver, and
• a growth component, whose impact is amplified when companies trade at high Price-to-Tangible-Book.
  
  Both depend on current pricing and future earnings or earnings growth.

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Today’s reading

• Cost of Equity (expected return): 7.76%
• 10-year U.S. Treasury: ~4%
• Equity Risk Premium: 3.74%
• Whole-period averages (2007–2025): Cost of Equity=8.40%, Equity Risk Premium=5.69%
  (calculated with Sismo’s default long-term macro anchors; all parameters are user-adjustable)
  
  Over the same period, the Russell 1000 Total Return Index delivered a 10.6 % compound annual growth rate, highlighting how realized equity performance and model-implied returns differ over full cycles.

What it means

1. A lower Cost of Equity implies higher valuations. At 7.76 %, we’re below the 18-year average but above the series low of Dec 2021 (6.77%) - which preceded a market drawdown.
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2. The Equity Risk Premium remains compressed, among the lowest levels in nearly two decades. The minimum (3.01 %) was reached in Nov 2024.
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3. We’re not at a point where expected returns are far below historical norms or near past extremes for the market as a whole - though certain segments may already look stretched.

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Context and research

Academic work (Fama & French 2002; Duarte & Rosa 2015; Damodaran 2023) defines the Equity Risk Premium as the market’s price of risk - the premium investors demand for holding equities over safe assets. It narrows when optimism rises or bond yields improve.

Estimating expected returns is always model-dependent. Sismo’s framework keeps parameters and data sources consistent since 2007 to ensure comparability over time.

The catch

Our model relies on rolling broker forecasts for the next three years. If these forecasts prove overly optimistic, both the earnings-yield and growth components decline - pushing implied expected returns lower and valuations higher.

Bottom line

We don’t see a bubble yet - but we do see compressed risk premiums and fragile growth assumptions. If analyst visibility holds, markets may hover. If not, gravity will do its work.

For those interested in the academic foundations and methodology behind Sismo’s Cost of Equity and Equity Risk Premium framework, feel free to contact us to explore it in depth.

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