A little perspective never hurts when surveying the equity landscape. There are no silver bullets, of course. But we must start somewhere in the thousand-mile journey of analyzing the possibilities in the land of equities, and a big-picture review of the global playing field is a reasonable way to begin.
For reasons of tradition and the usual obsessions, ranking the major slices of the world’s stock markets by trailing return gets the ball rolling. As our first chart below shows, recent history has been kind to equities, although the benevolence was far from evenly distributed. On one extreme was the 108% surge in Latin American equities last year; U.S. stocks, by comparison, were the low man at just under 30%, based on total returns via S&P BMI Global Indices.
One might wonder how these markets stack up in terms of valuation. A good question, for which there are many answers. For the moment, we offer just one, as indicated by the chart below, which graphs trailing 12-month dividend yields as of 2009’s close.
In the yield ranking, Europe tops the list with a 3.0% payout rate over the previous 12 months. Emerging European markets, meanwhile, are at the opposite extreme, posting a 0.9% trailing dividend yield.
Expected return and yield are related, as a number of studies show through the years. That said, the relationship isn’t perfect, at least not if we’re trying to assess the future in real time. Nor is it necessarily all that useful if we’re comparing various regions around the world. A more productive review of dividend yield comes by looking at the history of a given market. As an example, consider our third chart below.
The third graph above compares the current 12-month yield for the S&P 500 with the subsequent 10-year return on $1 invested in the index, as per analysis of data from Professor Robert Shiller. So, for instance, a dollar invested at the end of 1999, when the S&P 500’s yield was 1.15%, resulted in a loss over the subsequent 10 years. The last entry for the red line is about 78 cents, meaning that $1 dollar invested at 1999’s close was worth 78 cents at the end of 2009.
Looking over the trend in the past decades suggests that the current dividend yield offers a clue for future return in the long run. No guarantees, of course, which is why we should look to a range of metrics and analytical techniques for assessing the expected return on equities. But it’s hard not to notice the connection between relatively higher yields and relatively higher subsequent return, and vice versa. Again, no one should look at one chart and assume that the future is clear. But used in context with other evaluation measures, dividend yield is useful.
That said, what does the current yield on the S&P 500 suggest for returns looking out a decade or more? The good news is that yield is telling us that expected return appears to be positive, albeit less so than a year ago, when current yield was unusually high. That’s no great surprise. U.S. equity return in 2009 was extraordinarily high in terms of its own history. Dividend yield, along with a great many other market signals, now tell us to reduce our expectations relative to a year ago.
Deciding how much should we reduce expectations is another question entirely.