For years now, I’ve heard the debate continue about whether low bond yields are good for the stock market (since stocks’ dividend yields become a more attractive alternative) or in fact bad for the stock market because such low bond yields signaled market expectations of lower growth going forward. The entire debate reminds me that each and every view and trade is subject to your own perspective and interpretation. Today’s chart demonstrates this concept quite well.
The chart comes by way of the Abnormal Returns blog (who took the chart from the FT), and plots the equity dividend yield (of the S&P 500) vs. the 10-year Treasury bond yield over almost 100 years:
As you can see, bond yields are lower than equity yields for essentially the first time in more than 50 years. Many investors point to this as an obvious signal to buy stocks and sell bonds. But what struck me when I saw this chart was that from 1920 to 1955, equity yields consistently exceeded bond yields, and in some cases by 5%!
In other words, there is no rule that says that bond yields must be below equity yields, nor that they must be above equity yields. It does remind me of a conversation about this chart that I once had with a fellow trader, and he said, “well, people were stupid back then.” Of course, it was a comment made in jest, but in reality, I don’t think investors back then were clueless. Rather, they faced a much different set of circumstances (2 world wars and a depression) than the investors of the latter half of the 20th century.
The discussion is particularly relevant because Treasury bond yields are hovering at generational lows, and I just initiated a trade this week that anticipates even lower yields. In reality, I don’t view either camp as right. Instead of getting caught up in the question of who’s right in this debate, I prefer to listen to what macro price action is telling me. Because I’m sure pundits will be continuing this debate 50 years from now.