Dividend yields (D/P), as measure by the SPY benchmark, may seem attractive relative to bonds, but be careful and look qt these alternatives on a risk-adjusted basis.
Carry is expected dividend yield for equities and the expected yield for bonds minus the risk free rate of return when there is no change in underlying asset prices. The "carry" or stand-alone dividend yield is 1.89 which is right at the same place as 10-year Treasury yields. On a risk-adjusted basis, the equity versus bond carry is similar, (12% SPY volatility versus 11% 10-year Treasury volatility).
Carry is expected dividend yield for equities and the expected yield for bonds minus the risk free rate of return when there is no change in underlying asset prices. The "carry" or stand-alone dividend yield is 1.89 which is right at the same place as 10-year Treasury yields. On a risk-adjusted basis, the equity versus bond carry is similar, (12% SPY volatility versus 11% 10-year Treasury volatility).
The dividend yield is at some of the best levels in decades versus Treasuries, but the longer-term history including the first half of the 20th century, suggests that dividend yields can be much higher than bond yields. That is ancient history relative to our chart which shows the great Treasury yield advantage.
A key driver for the difference in carry yields is volatility. When long-term bond volatility has been high relative to equities, bond yields will exceed dividend yields. When equity volatility is high on a relative basis, dividend yields will exceed bond yields. After accounting for volatility, bond and dividend yields will be highly correlated. (See the older Financial Analyst Journal paper "Stocks versus Bonds: Explaining the Equity Risk Premium" by Cliff Asness.)
The low relative dividend yields to bonds may have more to do with relative volatility and overall low bond yields rather than any signal on valuation. That said, in the longer-run returns are more driven or comprised of dividend yields, so low D/P will suggest that future equity returns will be lower than during periods of high D/P. There can be individual equity dividend yield opportunities which can be exploited by rank ordering choices, but the equity benchmark does not offer any opportunities at current relative volatilities.
A key driver for the difference in carry yields is volatility. When long-term bond volatility has been high relative to equities, bond yields will exceed dividend yields. When equity volatility is high on a relative basis, dividend yields will exceed bond yields. After accounting for volatility, bond and dividend yields will be highly correlated. (See the older Financial Analyst Journal paper "Stocks versus Bonds: Explaining the Equity Risk Premium" by Cliff Asness.)
The low relative dividend yields to bonds may have more to do with relative volatility and overall low bond yields rather than any signal on valuation. That said, in the longer-run returns are more driven or comprised of dividend yields, so low D/P will suggest that future equity returns will be lower than during periods of high D/P. There can be individual equity dividend yield opportunities which can be exploited by rank ordering choices, but the equity benchmark does not offer any opportunities at current relative volatilities.
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