Friday, October 16, 2009

Dividend yield below 2%

Dividend payments from corporations continue to shrink. If one extrapolates all dividends over the past three months out to a full year, then the dividend yield of the S&P 500 index now stands at 1.97%.

Up until the mid 1990's, the normal range for the S&P yield was between 3% and 6%. In the late 1990's the yield made its first ever sustained dive below 3% as the dot-com bubble inflated prices. The yield finally rose back above 3% briefly in early 2009 as prices collapsed (yield = Dividends/Price) but since March it has been falling steeply as prices have risen and earnings have continued to dry up.

Assuming that earnings and dividends stabilize (an optimistic supposition) and that the yield returns to its historically familiar range, then the S&P 500 can be expected to fall eventually to between 720 and 360. However, if earnings and dividends continue to fall, then the "fair value" price range will be even lower.


qwerty said...

I fell into this trap myself. When trying to determine where the market will go next, always follow the money. Fundamentals are just one indicator of where the money might go; and often not a strong indicator, at that.

A strong rally was assured once interest rates at the investor level dropped to near zero. Any judgement on the appropriate level for the stock market average dividend yield must take into account the investment return for money-in-the-bank. That is now ZERO. 2% looks pretty good next to zero, especially once you convince yourself that the whole world is not going to end tomorrow (i.e. fear is under control) and there might be capital gains, to boot.

Well, fear is under control, and money in the bank is worth 0% and stocks and commodities are both rallying strongly - because there is no other viable place for the money to go and bring a better return.

The market will not go down again unless interest rates rise substantially and/or fear returns to the investor. NOrmalized to current short and medium term rates, the stock market obviously doesn't look expensive to those with cash on hand to invest.

Jody Wilson said...


Yes, I'm aware of the historical relationship between interest rates and the dividend yield, but I don't think it's reasonable to assume that the current extremes can be stable. Your comment suggests (without saying it in so many words) that interest rates may hover near zero indefinitely, which I don't think is possible.

Interest rates can only remain low so long as *someone* is willing to keep buying our debt at high prices. If China, Japan, Europe, etc. stop buying US treasuries, then bond prices will fall, interest rates will rise and ... poof. And that's just one possibility.

More to the point, the 2% dividend yield is rather inconsequential in the face of the 50% stock market rally that's occurred. I doubt many investors would stick around for a 50% drop from here just to collect the dividend.

H00b1e said...


If the scenario does play out as you outline, how long do you think it would take for the S&P 500 to drop to the 360-720 range?


Jody Wilson said...

Next year is a mid-term election year, and those have historically been long-term low points for the market, so it's reasonable to assume that a big retreat to a long-term bottom will happen within the next 12 months.

qwerty said...

Here we are almost 6 months later and even after the recent downdraft the market is up 10% (20% annualized capitol gains). Japan has had near zero interest rates for over a decade and the Yen is still supernaturally strong agains world currencies. I think this will go on until about two years after it seems impossible - THEN we'll have a crash heard round the world.