Sunday, 1 February 2015

Yields of Equities vs Bonds

I love charts, especially over a very long time frame. Unfortunately, most data is from the US, not from Asia (or more specific, from Malaysia or Singapore).

A beautiful graph can be here at found at "MarketAnthropology":

Black is the yield on 10 year US government bonds.
Red is the Dividend Yield on the S&P 500 (US).

I added the blue line:
  • On the left of it (roughly 1870 until 1960) is where the dividend yield tended to be higher than the yield on the bonds; the reasoning was simple, shares are more risky than bonds, so they need to yield more;
  • On the right of the blue line (roughly 1960 until 2010) is where the bond yield is higher than the dividend yield; the reasoning was that earnings (and thus dividends) are growing over time (through reinvested earnings), hence that makes equities more attractive in the long run (even when they are more risky in the short term).
The second interesting feature is that since roughly 2010 both yields together are at the lowest levels ever. For equities one reason could be increased share buyback programs which are in the US (from a tax point of view) more attractive than dividends (that argument doesn't hold in Malaysia or Singapore).

However, surely QE (quantitative easing), on an enormous (unprecedented) scale must have played an important role also, both for bonds and equities.

At the moment the dividend yield is higher than the yield on US 10 year government bonds.

From  "MarketAnthropology":

"For just the fourth time in the last fifty years, the S&P 500 yields more than 10-year Treasuries. If one was to mine the data, in the three previous occasions where this had occurred, equities rallied sharply over the short-term and strongly performed over the next year - quickly closing the aberration that represented a particular extreme between these two markets."

"That said, we would strongly caution anyone looking for similar returns or bolstering their respective equity biases with this fourth occurrence. From our perspective, the fourth time may be the charm as these two massive trends pass quietly in the night, ending an epoch that first set sail in 1959 as Treasury yields began their long and steep journey to a secular peak in 1981." 

I agree, I think that both equity and bond valuations in the US are high, and that QE has distorted things. The long term averages for both yields are clearly much higher than current values. A regression to the mean would imply that the prices for bonds and equities (not necessarily at the same time) would substantially fall.

When that will happen, one of course never knows, especially in a world that is so much distorted.

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