Are Equity Yields A Screaming Buy - Or Reversion To Reality?
In many countries around the world the main equity market has a dividend yield above its 10 year bond yield and in many cases its average IG credit yield. Although this isn't the first time that such an outcome has been seen through history, at a minimum it's reversing what has been a 50-year-plus trend where equity dividends were below bond yields. Currently, the US, UK, Germany, and France all have equity dividend yields above their 10 year govvie. However, before the world and their pet snake Sebastian decide this is the buying opportunity of a lifetime, a little more context shows that this was the normal from the start of the 20th century to around the end of World War II. In fact - if we replace government bond yields with corporate bond yields the picture appears to be a huge mean-reversion back to pre-World-War II relative valuations (where dividend yields were consistently higher than corporate bond yields). As Deutsche's Jim Reid notes though - it is more likely that it might be that fixed income and equities are both expensive as central banks have artificially elevated prices in everything in an attempt to keep the financial system solvent - and furthermore this is not the time for epic asset allocation switches.
Quite clearly, there have been two very significant regimes with regard the relative valuation of government bonds and equities. We suspect few have seen the full history as all too often the argument of high relative equity yields is only considered in the last 50 years...
and looked at on the more apples to apples basis of corporate bond financing vs equity capital (corporate bond yield vs equity dividend yield) - it is clear that we have seen two huge phases (red and green) and perhaps where we currently sit is a reversion to the pre-WWII spendathon era relative value perspective of stocks and bonds...
Charts: Deutsche Bank
Via Deutsche Bank:
There is little doubt that on the dividend vs. bond yield measure, equities look as good relative value as they have done for at least half a century. However it’s fair to say that both yields are low in absolute terms, but that bonds are at extreme levels relative to history.
Are the more competitive equity yields a threat to bond markets as funds look to switch out of fixed income for better value? It’s easy to conclude that the answer is yes but fixed income yields still need to be as low as the authorities can make them to ensure that the debt mountain that virtually all developed countries have across public and private sectors are funded smoothly. With this in mind it’s unlikely that regulatory flows will move substantially away from fixed income in the near future. We also may still see risk aversion regularly hit markets which will generally keep the bid for perceived safe havens high.
So while equities may out-perform bonds over any sensible medium-term horizon from this starting point, we’re not sure it will be through a conscious asset allocation switch. It will be more through dividend accumulation and re-investment against ultra low bond yield competition.