Dividends have long provided an extra boost to stock performance, but it is extremely rare for dividend-paying stocks to stack up as well against bonds, as they are today.
Dividends have long provided an extra boost to stock performance, but it is extremely rare for dividend-paying stocks to stack up as well against bonds, as they are today.
For the second time since 1947, the dividend yield on the S&P 500 has risen above the 10-year Treasury note yield. As of Jan. 10, the dividend yield on the S&P 500 stood at 2.2%, while the 10-year Treasury note was yielding 1.94%.
The last time this inversion occurred was in late 2008 and early 2009 when the stock market was at its nadir.
The significance of this phenomenon isn't just the absolute yield advantage but what it says about the shifting nature of risk across various asset classes.
“When the bond market and the stock market disagree, the bond market usually wins, and right now, the bond market is telling us that growth is going to be hard to come by,” said Rick Helm, who manages the $120 million Cohen & Steers Dividend Value Fund (DVFAX).
For example, the one-year-forward rate on that same 10-year Treasury is at 2.2%, suggesting an imminent, if subtle, upward market pressure on rates.
“The flight to quality has suppressed rates a little bit, but we look at that forward rate as an indicator that rates might be higher next year than they are today,” Mr. Helm said.
Anyone who is bearish about the global economy might be better off, at least psychologically, sticking with Treasury bonds, he said.
“But if you believe that we're turning the corner toward a long-term cycle of recovery, the risk is that interest rates start to rise and bonds are worth less money,” Mr. Helm said. “At these levels, it's hard to imagine that interest rates will continue to move lower.”
Essentially, when it comes to investment income, lenders in the form of bond holders are now among the least compensated players in the game, relative to the risk that they are taking.
“Right now, bond holders are getting 40% less than they were getting just a few years ago to make the same loans,” said Paul Hogan, manager of the $130 million FAM Equity Income Fund (FAMEX). “Bonds have had an incredible run, but now is the time to be a borrower, not a lender.”
Meanwhile, stock dividends, as an alternative or supplement to bonds, are shaping up to have better yields and less risk.
Last year, the S&P 500 gained 2.1%, which included an average return of 1.7% for the 107 non-dividend-payers in the index.
But among dividend payers, the 271 companies that have increased payouts at a compound average rate of up to 10% over the past five years averaged a 1.9% gain last year. The remaining 122 companies, which boosted payouts at a compound average rate of more than 10% over the past five years, gained an average of 5.9% last year.
Not only are dividend stocks among the strongest sources of income these days, the trend is your friend, as the economists like to say.
From a pure valuation standpoint, the S&P 500, with a trailing price-earnings ratio of about 13, is looking pretty cheap.
Consider this: Following the 1987 market crash, the S&P 500's P/E dropped to 10.4, and in March 2009, it stood at 10.7. To put that in perspective, the benchmark's P/E reached 17 in the lead-up to the 2008 financial crisis, and it was above 30 during the late 1990s technology bubble.
“Anyone concerned about being exposed to another bad market environment should realize they wouldn't be falling off the top step this time. They would be falling off the bottom step,” Mr. Hogan said.
Then there is the dividend aspect of the S&P 500, which is equal to 28% of earnings and is well below the historical average of a 50% payout.
“We could see that payout ratio move back toward 35% over the next couple of years,” Mr. Helm said.
Although none of this is to suggest a wholesale shift out of bonds and into dividend-paying stocks, it is clear that at this point in the market cycle that some of those assets often considered to be the safest might actually be among the riskiest.
“The time is now to be at the upper end of the equity allocation and at the lower end of the bond allocation, because if you're just sitting in bonds, you could be losing money in a measured way,” said Scott Schermerhorn, chief investment officer at Granite Investment Advisors, which manages $500 million, mostly in separate accounts.
Questions, observations, stock tips? E-mail Jeff Benjamin at jbenjamin@investmentnews.com
