BOND YIELDS RISING ABOVE STOCK YIELDS IS NOT A REASON FOR CONCERN
In early August 2020, the spread between the S&P 500 dividend yield and the yield on the U.S. 10-Year was about 1.3%, with the S&P 500 dividend yield at 1.8% and the U.S. 10-Year at 0.50%. At the end of February, the 2 yields had converged reducing the spread to nothing.
There are many factors at play here, but some of the most salient are:
1. The dividend yield falls as stocks rally
2. The 10-Year yield rises as bonds are sold off
3. Investors sell bonds as they predict a stronger economy
(chart below)
Some pundits have worried that a rising bond yield and a falling stock yield may predict coming weaker stock prices as bond yields become more attractive. A 2/26/21 WSJ.Marketwatch article entitled, So long, there-is-no-alternative trade. What should investors do now? Stated, “The swift and violent rise in bond yields has meant that equities are no longer the obvious choice to make on a relative valuation basis.” https://www.marketwatch.com/story/so-long-there-is-no-alternative-trade-what-now-11614339217?mod=home-page
The history of the S&P500 yield versus the U.S. 10 year yield shows that the spread between stock and bond yields was actually quite large until the Financial Recession. The U.S. 10 Year Yield was much higher than the S&P500 dividend yield from 1991 to 2008 (17 years). Yield levels have crossed multiple times since 2009.
Should stock investors be worried? Is there a distinct pattern of where investors should put their money when the bond yield crosses above the stock yield? TPA investigates these 2 questions below, but to eliminate the suspense, the answers upfront are NO to both questions.
TPA identified 3 obvious points since 2008 when the bond yield crossed above the stock yield and stayed there for some time (chart 2 below). TPA measured from the initial cross to the high part of the spread (before the 2 yields started to converge again). The periods measured were 11/10/16 to 11/2/18, 5/16/13 to 9/12/14, and 5/1/09 to 4/2/10. In charts 3, 4, and 5 the upper panel shows the stock and bond yields and the lower panel shows the relative performance of the TECH, Consumer, Healthcare, Financials, and Industrials sectors that makeup 84% of the S&P500.
STOCKS
TPA does not see a reason to worry about stocks using the historical precedent after the bond yield crosses above the stock yield. In all 3 periods the S&P500 was up 20% or more.
SECTORS
TPA did not see a clear pattern of relative performance among the 5 major sectors that make up 84% of the S&P 500.
For example:
· Financials underperformed the S&P500 from 11/10/16 to 11/2/18, but were the best performing sector from 5/1/09 to 4/2/10.
· TECH was the best performer from 11/10/16 to 11/2/18, but only middle of the road in the 5/1/09 to 4/2/10 period.
· Industrials were the worst-performing sector 11/10/16 to 11/2/18, but a middle-of-the-road performer in the other 2 periods.
We conclude that if you are looking for a reason to sell stocks, the U.S. 10 year yield crossing above the S&P500 dividend yield is not a good reason. Also, that the bond yield crossing above the yield for stocks does not provide a valid roadmap for allocating among sectors.
