We’ve been wracking our brains looking for interest rates that will never go negative regardless of what the global bond market does, and we can only come up with two. The first is US credit card rates. At present those average 15.1%, the highest since February 2001. Fed Funds were 5.5% back then and the 10-year Treasury yielded 4.9%. Clearly, credit cards issued by US banks are impervious to lower rates.
The other is the yield paid by public equities. Even during the 2008 Financial Crisis and its aftermath the S&P 500 paid $22/share in annualized dividends. Yes, that was down 24% from the 2008 peak. But dividend payments did not go to zero, let alone negative. To borrow from the Fed’s vernacular, there is a hard “zero lower bound” on the dividend yield paid by public companies. And you’ll never get a bill from a company for owning their shares.
With recession fears in the air just now, the logical question is “how safe is the current payout on something like the S&P 500?” The short answer is “very”:
- The trailing 4-quarter payout ratio (dividends divided by net operating earnings for the 12 months ending 3/2019) is 36%. This is bang inline with the prior cycle average, the same 36%.
- S&P companies are currently spending 77% more on stock buybacks than dividends ($823 billion vs. $464 billion for the trailing 4 quarters ending 3/2019).
- Managements know dividend cuts correlate with company boards opting for new leadership, so they will reduce buybacks long before they opt for slashing quarterly payouts.
So how does the current S&P 500 yield compare to Treasuries and what’s the downside case?
- At today’s close the index pays a 1.9% yield based on the last 4 quarters of dividends.
- That is 126% of today’s 10-year Treasury yield (1.5%).
- Let’s assume the bears are right, and we’re heading for a 2008-style meltdown. That means the forward looking yield on the S&P is 24% lower, or 1.4%. Essentially the same, in other words, as the 10-year Treasury.
This means that even in a dire outcome the S&P 500 pays the same as Treasuries today; how does that compare to historical averages? We pulled the data from Nobel Prize winner Robert Shiller’s website for 10-year Treasury and actual S&P yields back to 1940 (chart below). Here is what that shows:
- From World War II to 1957, US stocks did typically pay more than Treasuries – an average of 121% more. Credit an abnormally low yield on Treasuries to finance the war, and the absence of other risk-free financial assets in the decade of rebuilding that followed.
- Past that, from 1958 to 2007, stocks yielded much less than Treasuries – basically half (an average of 49%).
- Since the Financial Crisis, the record is spottier. In some years (2008, 2011, 2012, 2014, 2015) stocks yielded more than Treasuries. In others (2009, 2010, 2013, 2016 – 2018), they paid less.
The key investment takeaways from all this:
- Recent history says there is no correlation between S&P/Treasury yield ratios and stock performance. Relative yield alone is not enough to call a bottom or top on stocks.
- At the same time, the fact that US stocks deliver guaranteed non-zero payouts is increasingly relevant as global rates decline and in some cases yield less than zero.
- In a 2008 worst-case scenario, S&P 500 dividend yields will match the payout on Treasuries today. If we only get a garden-variety recession, stock payouts will beat Treasuries. And if we skate by a recession, they will be much better still.
The bottom line: in a world seemingly gone mad for “safe” yield at any price, US equities are looking reasonably attractive simply for their payouts. That will not dampen volatility, as we’ve been explaining in recent weeks. But for investors who want to do better than Treasuries, have some upside potential from higher payouts and eventual capital appreciation, stocks are one place to look.
And you’ll never see a negative dividend check; that much we’re sure of.