The continued slide in fixed-income yields has left the majority of North American equities in a rare situation: they now boast larger dividend yields than the 10-year rate on sovereign bonds.
Bespoke Investment Group observed last Friday that the S&P 500's dividend yield crossed above that of the 10-year U.S. Treasury yield for the first time since August, 2011. As of late Tuesday, the dividend yield of the benchmark U.S. equities index was at 1.99 per cent, eclipsing the 1.8 per cent yield of the 10-year note.
The 10-year yield had also dipped below the benchmark index's dividend yield in late 2008, a few months before the market troughed. Before that, however, the S&P 500's dividend yield exceeded the 10-year's for only one day in the previous 46 years – on June 22, 1962.
Admittedly, this is a tiny sample size, but these "crossover" days have proved to be profitable buying opportunities.
"Following each occurrence, the S&P 500 saw consistently positive returns, with a median gain of 7.8 per cent just one month later to a median return of 33.4 per cent over the following year," said Bespoke. "While these past performances don't guarantee similar returns going forward, they are pretty compelling."
The money management and research firm does warn that these previous three episodes came about via a notable decline in the S&P 500; this time around, sinking bond yields were the dominant factor.
"With a smaller initial decline and the index trading at less oversold levels, the likelihood of such a steep rebound is less likely," the authors write.
Meanwhile, in Canada, not only is the 2.94 per cent dividend yield of the S&P/TSX Composite above the 10-year Government of Canada bond yield of 1.49 per cent, but about 55 per cent of issues have dividend yields higher than the 30-year yield of 2.06 per cent.
Assuming inflation will average 2 per cent, which is something it's done for more than 20 years since the Bank of Canada adopted an explicit inflation target, this long-term fixed income offering is set to provide a slim return, in real terms.
The composition of the Canadian equity market, which is more heavily weighted toward the high-yielding financials, energy, utilities and telecom sectors than its counterpart to the south, helps explain the yield discrepancy between the two – as does the fact that the TSX/S&P composite has had a rocky ride as of late.
Granted, dividend yields and bond yields do not make for an apples-to-apples comparison. Fixed-income payments from sovereign bonds are considered to be risk-free, while dividend payouts can diminish if the company's financial position or growth prospects deteriorate– something many Canadians with holdings in the energy sector know all too well. Nevertheless, low bond yields certainly figure into the asset allocation process and should steer investors towards boosting their exposure to equities, all else equal.
If you're part of the 69 per cent of Canadians who, according to a recent CIBC poll, plan to invest mainly in domestic funds, now might make a good time to rebalance into American equities, as this dividend yield premium relative to fixed income doesn't come around every day.
Dividend-hungry investors who wish to expand their domestic holdings will also have no shortage of options to choose – but just be careful not to pick the next Lightsteam Resources Ltd.