Although mutual funds reporting to the Investment Funds Institute of Canada saw $12 billion in combined net sales in 2010, investors yanked out more than $7 billion from equity funds. So, the fund industry is trying to lure investors back into equity funds. But one of the industry’s key arguments isn’t well supported by the data — past or present.
A few firms have been promoting the fact that dividend yields on many stocks now exceed yields on government bonds — which, they contend, has rarely been the case. This situation, they add, coupled with the fact that equities offer the potential of dividend growth and capital appreciation, means stocks are a relative bargain.
The argument doesn’t hold when looking at broad markets. The S&P/Citigroup developed broad market index boasted a dividend yield of slightly more than 2% as of Dec. 31, 2010. Aside from a few S&P broad market indices, such as the Czech Republic (6% dividend yield) and a few smaller countries, the vast majority of stock markets yielded well below 3% — less than long-bond yields.
And using data provided by Yale University economics professor Robert Schiller, I found that 10-year U.S. Treasury bond yields have exceeded dividend yields on U.S. stocks since the summer of 1958. The exception was a short window from the autumn of 2008 to early 2009, during which the S&P 500 dividend yield peaked at 3.5% — the first time it had touched 3% since 1992. More interesting, however, is the situation that prevailed before the summer of 1958.
From the start of Schiller’s data in January 1871 through July of 1958 — almost 90 years — U.S. stocks’ dividend yield was almost always higher than the yield on 10-year T-bonds. The only exceptions were brief, during times of frothy stock prices, such as in 1928, before the mother of all bear markets arrived.
This 87-year record should give financial advisors cause to question today’s specious argument about the rarity of stocks’ excess yield. This ar-gu-ment is often used in conjunction with the notion of an impending bond bear market to convince clients that stocks are the place to be.
Speaking of the fear of a possible bond bear market, let’s put it in perspective: the worst bond markets in North America occurred in 1994 and in 1980, when losses clocked in at 10% and 12%, respectively. Those losses resulted from swift interest rate hikes within months. The more gradual the rate increases, the less clients will notice the damage to bond prices. And even the worst bond market to date pales in comparison to the typical 40% loss that stocks have experienced every nine years or so.
Bonds play two key roles in client portfolios. They remain a source of stable — but not high — income. More important, bonds’ function as preservers of capital is as valid today as ever. Diversification into bonds saved investors’ hides in 2008 and allowed balanced portfolios to recoup those bear-market losses.
This discussion brings us back to diversifying prudently among and within asset classes while structuring portfolios based on clients’ short- and long-term goals. IE
Dan Hallett, CFA, CFP, is director, asset management, for Oakville, Ont.-based HighView Financial Group, which designs portfolio solutions for advisors, affluent families and institutions.