Are you spooked by the two-year Treasury yield rising above the S&P 500’s dividend yield? You shouldn’t be.
To be sure, many analysts disagree. They have been circulating a version of the chart below, pointing out that the summer of 2008 was the last time the two-year yield was higher than the market’s dividend yield. We all know what happened soon thereafter.
As you can also see from the chart, the two-year yield was continuously above the market’s dividend yield for the three decades prior to 2008. The S&P 500
on balance did just fine over those decades, of course, including turning in one of the strongest bull markets in U.S. history.
So the next time someone tries to scare you by pointing out that the two-year yield has eclipsed the market’s dividend yield, ask them to explain the market’s strength over those three decades prior to 2008.
The data below show the S&P 500’s dividend-adjusted 12-month return depending on the differential between the two-year yield and the stock market’s dividend yield.
|When…||S&P 500’s average dividend-adjusted return over subsequent 12-months|
|The S&P 500’s dividend yield was more than 5 percentage points higher than the two-year yield||13.1%|
|The dividend yield was higher than the two-year yield, but by less than 5 percentage points||11.0%|
|The two-year yield was higher than the dividend yield||10.2%|
None of these differences is significant at the 95% confidence level that statisticians often use to determine that a pattern is genuine.
You should also be aware that there are theoretical objections to making simple comparisons between the two-year yield, currently at 2.08%, and the S&P 500 dividend yield, currently at 1.82%. In many ways it’s an apples-to-oranges comparison: The market’s dividend yield is a function of both the stock market’s overall level (a higher market results in a lower yield) and investors’ confidence in companies maintaining their dividends. The myriad factors impacting those considerations are far different than what is the proper risk-free rate of return. So it’s not at all clear what the markets are telling us when the two different yields converge or diverge.
None of this discussion means that there aren’t plenty of other things to worry about. But my contrarian instincts get triggered when I read analyses that have superficial plausibility but are in fact nothing more than sloppy thinking.