October 9, 2008
FEAR AND VALUE: TOGETHER AGAIN
The classic conundrum in strategic investing is that relative bargains in the stock market tend to arrive when buyers go on strike. There's no mystery as to underlying cause, as current events remind.
Consider our chart below, which shows month-end trailing equity dividend yields for the major regions of the developed economies. The trend of late is clear: yields are rising, dramatically so in recent months. European yields lead the pack at 4.93% at last month's close, based on S&P Global Equity Indices. The U.S., Asia Pacific and the developed world-ex-US are also posting substantially higher dividend yields compared to recent years. For reasons that need no explanation, however, investors are reluctant to avail themselves of these higher yields. For comparison, the yield on the benchmark 10-year Treasury Note closed out September 2008 at 3.85%.
Perhaps avoiding equities (broadly defined) with relatively high yields is prudent at the moment, perhaps not. Yield, after all, is but one component of total return for equities. The other key variables are capital gains and changes in valuation. All three are ultimately speculative in ex ante terms. But if today's higher yields are unappealing, one might ask why the relatively skimpy yields of 2003-2007 deterred almost no one from owning equities? Was it that the outlook for capital gains were so bright that yields did not matter? If so, were expectations for capital gains reasonable or something less? Tackling such questions is as much a job for a psychologist as it is for a financial analyst. In any case, we're better at asking questions than providing definitive answers, in part because we see the past so clearly and are forever fuzzy about what's coming.
Rest assured that the true answers reduce down to the age-old explanation of fear and greed. The duo is always at work, of course, although at times one or the other dominates to the extent that the other is overlooked, dismissed if not left for dead. Until, that is, the cycle changes. The process, we're sure, will endure, along with weather patterns and sunspots.
In short, dividend yields and other fundamental measures will remain in a constant state of flux, which implies (but doesn't guarantee) that prospective returns vary through time as well.
That's meaningless information if you're looking to turn a quick buck over the next month or even year. But what about investors with time horizons of five years or more? The possibilities--maybe, perhaps--aren't quite as dire as the headlines suggest.
Posted by jp at October 9, 2008 9:33 AM
Using Shiller's updated data on "real" S&P500 price, dividend, and earnings since 1871, the current S&P500 yield (6/2008) remains dramatically low by historical standards: 2.1% vs. a 4.5% mean, a ranking in the 75th percentile. In comparison, I can get FDIC insured 2-yr. CDs at 4% or better. By the same token, the PE ratio (for those looking at value for growth and gains) is also equally outside the norm at 21.8 (3/2008) vs. a 14.9 mean. Research Shiller and others have done suggest that, at this PE ratio, 10-yr. returns using this data will be well below average, possibly negative. So, from this investor's perspective, there is little reason to plunge into the stock market anytime soon.
Posted by: Terry at October 9, 2008 9:55 AM