Why the stock market isn't paying you much right now

For the first time in years, bonds are paying a decent, after-inflation return, and that presents a challenge to the logic of owning stocks.

Why it matters: It could become a headwind for the stock market.

The big picture: At the risk of oversimplifying, all investors face a variant of this basic choice: stocks or bonds?

• One way investors decide where to put their money is by comparing the expected returns on these two cornerstone investments.

State of play: Over the last year or so, the Federal Reserve's interest rate hikes have translated into higher yields, and higher returns, for bond investors.

• Investors can now lock in a decade of real (after inflation) risk-free annual returns of almost 2% on their money, simply by buying 10-year inflation-protected Treasuries.

Be smart: Yields on inflation-protected Treasuries (also known as TIPS) serve as a key yardstick against which other investments can be measured.

• That's because these Treasury bonds are basically the closest thing investors can find to riskless investment.
• As the logic goes, because everything else is by definition riskier, those investments should pay a premium to investors for taking that risk.

The intrigue: But how high a premium do investors need?

How it works: To figure that out you need to establish some sort of "yield" for the stock market, which you can then compare to the yield on TIPS.

• Financial analysts and investors have settled on something known as the "earnings yield" of the market, as the preferred metric.
• The earnings yield is basically the inverse of the price-to-earnings ratio.
• It's a statistical fiction that reimagines the stock market as a big bond; the earnings-per-share plays the role of the bond's "yield."

Be smart: Despite the mathematical nature of this analysis, this is art, not science. There are plenty of ways to calculate and compare these numbers.

• I've calculated the earnings yield on the S&P 500, by looking at expected earnings per share of the index over the next 12 months. That gives me an earnings yield of about 5.4%.
• To get the risk premium, you then subtract the 1.9% TIPS yield from that number, giving you a 3.5 percentage point difference.

Translation: The stock market is paying you a paltry premium of just 3.5 percentage points to put your money on the stock market roller coaster, versus the sure thing of government bonds.

The bottom line: That's the most parsimonious premium markets have offered stock market investors in 20 years, since late 2003.

• And that could have big implications for the direction of the market.