For the past five decades, it's been normal for U.S. government bonds to yield more than U.S. stocks. But that's slowly changing, as bond yields fall to surprisingly low levels and corporations pay out more and more of their earnings in the form of dividends.
Currently, the spread between the S&P 500 dividend yield and the 10-year Treasury bond yield is 0.5%, around the highest levels of the year.
In the postwar era, stock dividend yields first surpassed bond yields in 2009, when the S&P 500 more than halved in value during the financial crisis.
S&P 500 Dividend Yield - 10-Year Treasury Yield Spread
Back then, the yield differential peaked at nearly 1.2% in favor of stocks before retreating to 2% in favor of bonds in 2010 amid hopes that things could get back to normal once the worst of the crisis passed.
They never did get back to normal. Economic growth and inflation remain sluggish despite unprecedented monetary stimulus, and more and more investors are resigning themselves to a new normal of lower interest rates.
S&P 500 Dividend Yield (Blue) vs. 10-Year Treasury Yield (Orange)
Savings Glut Drives Rates Lower
There are a number of reasons that analysts point to in order to explain this new paradigm, but demographics may be the most important factor driving interest rates lower.
A report from the Wall Street Journal shows that, since 2008, when the first baby boomers were eligible to receive Social Security benefits, the labor force has only grown 0.2% annually, compared with 1.2% in the decade before that.
A smaller labor force results in slower economic growth.
The aging of the population also has another effect. Older people tend to save more compared with younger people; thus, as the population ages, overall savings increases, reducing interest rates.
Some analysts have gone as far as to say that there is a "savings glut" in the world today.
Corporations Return Cash To Shareholders
Meanwhile, another contributing factor to the slower growth paradigm is less investment on the part of businesses (less investment translates into reduced growth potential for the economy in the future).
Since 2008, gross private nonresidential domestic investment in the U.S. grew at only a 1.7% clip. That compares with 4.7% in the decade before 2008, and 4.6% for the entire postwar era.
Rather than invest, many companies are choosing to hold on to their cash or pay it back to shareholders in the form of stock buybacks and dividends.
That helps explain why the dividend yield on the S&P 500 reached a seven-year high of 2.4% earlier this year. Excluding the financial crisis period (when the stock index plunged, sending the dividend yield briefly above 4%), current yield levels are at the highest levels since 1995.
Incidentally, the "buyback yield," for the S&P 500―which is based on corporations repurchasing their own shares―is around 3%, according to FactSet. Buybacks are another way for corporations to return money to shareholders, and tend to be more volatile than dividend payments. Combined, the dividend plus buyback yield on the S&P 500 is currently 5.2%.
Higher Equity Allocation May Be Necessary
Lower interest rates are something that investors may need to get used to. A higher allocation to equity markets may be needed to generate the returns that investors want, but that comes with higher risk.
On the plus side, corporations are currently very generous with the amount of money they're returning to shareholders, which is a boon for investors seeking steady income above and beyond what they can get in the Treasury market.
Contact Sumit Roy at [email protected].