Finding Yield in a Low-to-No Yield Environment
Sources: Sources for data in tables: Equity Market and Fixed Income returns are from JP Morgan as of 08/23/19. Rates and Economic Calendar Data from Bloomberg as of 08/23/19. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index. Sector performance is measured using GICS methodology.
Global capital markets were mostly lower for the week as investors paid close attention to central bank messaging out of Jackson Hole, an annual gathering of the world’s most prominent central bank figures. In the U.S., the S&P 500 Index fell to a level of 2847, representing a loss of 1.42%, while the Russell Midcap Index fell 1.40% for the week. The Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, lost 2.27%. On the international equities front, developed markets moved 0.86% higher, while emerging markets followed suit increasing 0.38%. Finally, the 10 year U.S. Treasury yield continued to nosedive, finishing out the week at just 1.52%.
In the current “low-to-no yield” environment, many investors are naturally scratching their heads, trying to figure out where to find a reasonable level of yield without taking on unnecessary levels of risk. Moreover, traditional fixed income investors starved for yield are wondering if equity markets might be the solution to their income shortfall. In judging the attractiveness of equity markets in relation to fixed income markets, we have long looked to ratios such as the Fed Model which divides the S&P 500 earnings yield by the 10-year Treasury yield. A resulting number higher than one indicates equities are relatively more attractive in this context. The current Fed Model ratio is well above one.
Another useful tool is to consider the spread between the S&P 500 dividend yield and the 10-year US Treasury yield. The chart below depicts this relationship over the last nine years; this spread will be positive anytime the S&P 500’s dividend yield is higher than the yield on the 10-year Treasury. In either case you’ll find that the most recent reading signals relative strength in stocks.
It shouldn’t serve as a significant surprise that stocks are relatively more attractive (though not necessarily to all investors based upon their specific goals, risk tolerance and requirements) than bonds given the 10-year Treasury is yielding just north of 1.50% and is currently expected to drop precipitously over the coming months and years, while the dividend yield on the S&P 500 is 1.95% and forecast to move higher. Even though equities look comparatively more attractive, and can be used to supplement a portfolios income shortfall, we understand that this must be done within reason. In other words, all stocks are not created equal, and any strategy intending to supplement a small portion of fixed-income with stock exposure must deploy a high degree of caution and target highly specific segments of the stock universe. As a result, we encourage investors to stay disciplined and work with experienced financial professionals to help manage their portfolios through various market cycles within an appropriately diversified framework that is consistent with their objectives, time-frame, and tolerance for risk.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.
The prices of small company and mid cap stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.