Since “There Is No Alternative” has become such a mainstream phrase in the investing community, I wanted to look this morning at the relationship between the 10 year swap rate and the S&P 500 Dividend Yield.
The recent rise in interest rates has resulted in the largest gap between the 10 year rate (around 2.67% this morning) and the 12 month gross dividend yield for the SPX index (around 2.12%) since the summer of 2011:
The real driver of this relationship is the interest rate. The dividend yield in the S&P 500 has been relatively unchanged, around 2% over the past 3 years. As a result, when I plot the difference between the 10 year rate and the S&P 500 dividend yield, it looks very similar to the chart of 10 Year Treasury Bonds:
But the real argument for “TINA” comes from the comparison of the dividend yield vs. rates over the last 30 years. In that respect, the argument goes that stocks still look cheap on a pure dividend yield vs. interest rate comparison, relative to the last several decades in the U.S.:
Here is where the yield reach story starts to look more attractive. Stocks are much more attractive because bonds offer a much smaller incremental yield today vs. recent history. But by that logic, any region of the world where interest rates are low offers a much better risk/reward to own stocks rather than bonds. Japan’s poor stock market performance over the last 20 years seems to refute that simple yield vs. interest rate argument.
The crucial question is – why are interest rates so low? In Japan’s case, it has been because of deflation. There are some concerning signs globally that inflation remains a more significant risk than inflation. In that case, low interest rates are more a symptom of overcapacity than a catalyst for future growth.
During the first half of the 20th century in the U.S., the S&P 500 dividend yield was usually above the prevailing interest rate, but that was not an automatic buy signal for stocks. Extra yield can be a nice investing treat, but it shouldn’t be relied on as a standalone argument. In today’s environment, the high yielders often look more risky than the “risky” cyclicals of the past. Don’t be fooled by the sales pitch – there is always an alternative.