Last Updated: 29 November 2022
Japanese 10-year bond yields have dipped below 1% for the first time in seven years, reports today’s Financial Times. Meanwhile, the yield on Japan’s Topix equity index is double that, according to Barron’s, so you’re paid twice as much to hold equities as government bonds.
In the US, a yield comparison using dividends isn’t quite as compelling for an equity investor: 2.9% on 10-year Treasuries, compared with 1.96% on the S&P 500. Nevertheless, the Fed Model, which compares the equity market’s earnings yield (the inverse of its price/earnings ratio) with bond yields, shows equities yielding nearly 4% more than bonds, a level that looks very favourable for stocks on the basis of recent history.
According to Jason DeSena Trennert, chief investment strategist at Strategas Research Partners, quoted in last weekend’s Wall Street Journal, the gap between US stocks’ earnings yield and the 10-year Treasury bond yield is at its widest in 30 years.
“People are so risk-averse now that a tremendous potential opportunity is being created in stocks,” according to Trennert.
In the UK, the May-June market selloff pushed the average equity dividend yield above government bond yields for the first time since 2008, while in Europe, equity yields rose above those on corporate bonds. In Switzerland, like Japan, equities recently offered twice the income available from government bonds, according to Tony Jackson of the Financial Times.
There are some exceptions to the trend: in Greece, for example, the recent panic over the government’s solvency pushed government bond yields to double those on the country’s shares.
But based upon the historical experience of almost everyone currently working in finance, the Treasury-equity yield comparison now suggests that we should buy stocks and sell bonds in most developed markets.
And yet, should we be looking further back in time?
Professor Robert Shiller’s database of US stock price information, for example, goes back to 1871. A comparison of long-term bond yields and equity dividend yields from that date shows that equities yielded more than bonds for over half the 140-year period. It was only from the late-1950s, when the “cult of the equity” began (and US inflation started to accelerate) that there was a major relative shift in the other direction (bond yields up, equity yields down).
Is the recent narrowing of the gap between US bond and equity yields (and, in other markets, a move to equities yielding more than bonds) therefore a possible signal that we are returning to the pre-1960 state of affairs? It’s worth remembering that when bonds started to yield more than shares after that date, market participants referred to this “new” state of affairs as the “reverse yield gap”. The normal yield gap, in other words, was with equities as the higher-yielding asset.
Time will tell. If nothing else, a longer historical perspective reminds us not to set too much store by recent models of financial interrelationships.
And, on a separate note, if we really are going back to a world where equities yield more than bonds (and are purchased primarily as riskier, income-producing assets, rather than as vehicles for achieving capital gains), then making sure you actually receive that equity income will be paramount. As we highlighted on IndexUniverse.eu earlier this week (“Those Leaky Dividends”), it’s easy to lose out on a substantial proportion of ETFs’ underlying dividend income without even being aware of it.