July 10, 2008
WATCH THOSE YIELDS
Equity markets are down, which means that dividend yields are up.
It's a fundamental relationship, and one that endures. No wonder, then, that a growing body of academic research (and a healthy dose of common sense) counsels that the relationship produces valuable clues for strategic-minded investors. In short, raise equity weights when yields are relatively high, and trim that exposure when yields are relatively low. Ideally, such shifts are done gradually, over time, to manage the risk that no one really knows if current yields will remain the apex, or trough, for the cycle.
There are other factors to consider in managing portfolios of course. For the moment, however, we'll focus on dividend yields, which are up these days, as our chart below shows. Indeed, some corners of the world's equities markets are sporting rather attractive yields, relative to recent history.
Europe leads the way among the globe's major regions, posting a 4.35% yield (based on the trailing 12 months) as of June 30, 2008. (All data is via S&P/Citigroup Global Equity Indices.) How high is 4.35%? It's the highest in at least 13 years. After factoring in the selling so far this month, the current trailing yield is almost certainly a bit higher today.
By comparison, the U.S. trailing yield is quite a bit lower at 2.0%, although relatively speaking that's close to a new high based on data since 1995. And if we consider the continued selling this month, we may already at a new high in yields in the U.S. market generally.
Meanwhile, developed markets in Asia are at a new post-1995 yield high, as is the developed-world equity market ex-U.S.
It's a different story in emerging market stocks. As our second chart below reveals, yields are still middling relative to the their history since 1995, ranging from 1.38% for Latin America up to 2.65% emerging Asian markets, as of June 30. Of course, one might argue that the allure of the emerging world is the growth potential rather than its yield capabilities, and so dividends aren't all that important here. Perhaps, although for the moment there's not much growth in share prices anywhere and so dividends are a lone bright spot.
In the long run, dividends do matter, at least for a broadly diversified portfolio. No one should buy, or sell stocks solely because of dividends, of course, or any other single metric. But neither should strategic-minded investors ignore the income stream produced by stocks. Indeed, when equity yields move to extremes, the associated signals about prospective returns are more reliable. History, at least, tells us so.
The eternal question, of course, is whether we can accurately identify extreme levels in real time. Inevitably, that's a speculative task and prone to error. Nonetheless, it's clear that in some markets we're quite a bit closer to the extreme than we have been in quite a while. As a result, the odds have improved for buying now in anticipation of receiving relatively higher total returns over the next five years-plus compared with buying six months ago.
That doesn't mean that yields won't be even higher down the road, or that buying today insures a profit as of, say, July 10, 2013. The future is always unclear, and that introduces risk. But at least we have some clues about what's coming, a message that boils down to the basic lesson that Ben Graham taught us all those years ago: valuation matters.
Posted by jp at July 10, 2008 8:59 AM
Wouldn't you say that dividend yields for emerging markets are more important due to the corruption and laxity of accounting standards? You can fake numbers on your income statements by paying off the auditor but you can't give out fake dividends.
Posted by: Zirill at July 10, 2008 12:45 PM