Market Snapshot: A Battle of Yields
In a Battle of Yields, Stocks now offer more than Treasuries
The recent decline in bond yields has helped the dividend yield on the S&P 500 converge with the 10 Year Treasury Yield. This has happened only a few times since the Fed embarked on quantitative easing and led to questions about whether equities are historically attractive despite fairly high absolute valuation levels. Prior to these recent occurrences, this relationship hadn’t occurred during the investing lifetime for most of us. This is highlighted in the red box in Exhibit 1, which shows the spread between the dividend yield and the 10 Year Treasury Yield.
Prior to the precipitous rise of interest rates in the 1960s and 70s, the dividend yield above the bond yield was the normal state of affairs. There are a variety of potential explanations for this. One explanation is during much of that earlier period, dividends were the primary way companies returned cash to shareholders and dividend payout ratios were relatively high. Today, a significant portion of cash returns is realized through share repurchases with lower dividend payout ratios. Therefore, one should probably expect a lower dividend yield measure today.
However, the difference in today’s environment is that the bond market’s rally has pushed yields on longer term Treasuries to historic lows leaving equities as a potential source of income for investors searching for yield. As shown in Exhibit 2, as of August 31, 2019, eight out of eleven sectors (all but Communication Services, Consumer Discretionary, and Information Technology) have dividend yields that are greater than 1.5%. In terms of individual stocks, 59% of the S&P 500 (or 299 stocks out of 505) have yields in excess of the 10-year yield.
Falling bond yields offer support to equity valuation levels and very low/negative nominal yields help fuel discussion about TINA (There Is No Alternative). In the search for yield, long term investors now have more investment options when stocks are considered.
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