ORLANDO, Florida, June 11 (Reuters) - Calm has descended

on U.S. markets following the 'Liberation Day' tariff turmoil of

early April. But Wall Street's rally has revived questions about

U.S. equity valuations, as stocks once again look super pricey

compared to bonds.

Since the chaotic days of early April, U.S. equities have

rebounded fiercely, with the S&P 500 up 25%, putting the Shiller

cyclically adjusted price-earnings (CAPE) ratio for the index in

the 94th percentile going back to the 1950s, according to bond

giant PIMCO.

Stocks are looking expensive in absolute terms, and in

relation to bonds. The equity risk premium (ERP), the difference

between equity yields and bond yields, is near historically low

levels.

According to analysts at PIMCO, the ERP is now zero. The

previous two times it fell to zero or below were in 1987 and

1996-2001. In both instances, the ultra-low ERP precipitated a

steep equity drawdown and sharp fall in long-dated bond yields.

"The U.S. equity risk premium ... is exceptionally low by

historical standards," they wrote in their five-year outlook on

Tuesday. "A mean reversion to a higher equity risk premium

typically involves a bond rally, an equity sell-off, or both."

But reversion to the mean doesn't just happen by magic. A

catalyst is needed. Equities have recovered largely because they

were oversold in April, trade tensions have been dialed down,

and investors remain confident that Big Tech will drive solid

AI-led earnings growth.

So even though huge economic, trade, and policy risks

continue to hang over markets, there is no sign of an imminent

catalyst that would cause an equity market selloff.

CHEAP FOR A REASON

The flip side of equities looking expensive is that bonds

look like a bargain.

Indeed, the relative divergence between stocks and bonds is

such that, by one measure, U.S. fixed income assets are the

cheapest relative to equities in over half a century.

Using national flow of funds data from the Federal Reserve,

retired strategist Jim Paulsen calculates that the total market

value of U.S. bonds as a percentage share of the total market

value of U.S. equities is the lowest since the early 1970s.

"Since the aggregate U.S. portfolio is currently

aggressively positioned, investors may have far more capacity

and desire to boost bond holdings in the coming years than most

appreciate," Paulsen wrote last week.

But bonds are 'cheap' for a reason. Washington's profligacy

- the reason ratings agency Moody's recently stripped the U.S.

of its triple-A credit rating - and inflation worries have kept

yields stubbornly high. The term premium - the risk premium

investors demand for holding long-term debt rather than rolling

over short-dated loans - is the highest in over a decade,

reflecting concerns about Uncle Sam's long-term fiscal health.

And the diagnosis here shows no signs of improving.

President Donald Trump's 'Big Beautiful Bill' is expected to add

$2.4 trillion to the U.S. debt over the next decade, according

to the nonpartisan Congressional Budget Office, likely putting

more upward pressure on yields.

Of course, equity investors do seem to be pricing in a very

rosy scenario, and the past few months have shown how quickly

the market landscape can change. The U.S. economy could weaken

more than expected, the trade war could escalate, or there could

be a geopolitical surprise that causes bond yields and equity

prices to fall.

Investors should therefore be mindful of the warnings being

sent by ERPs and other absolute and relative valuation metrics.

However, they should also remember that stretched valuations can

get even more stretched. As the famous saying goes, markets can

stay irrational longer than investors can remain solvent.

(The opinions expressed here are those of the author,

a columnist for Reuters)

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