Desire for Safety Is Making Investors Short Sighted

We’ve recently come to recognize the herd mentality that’s been corralling the minds of retail investors and how this has led to a ‘bubble’ in U.S. Treasuries. This phenomenon reflects the extreme risk aversion that’s moving the markets these days and how people are more focused on return of investment than return on investment.

Even though the yield on Treasuries is at historically low levels, investors are willing to sacrifice the returns they need for the sense of security they want. Unfortunately, this fixation with ‘safe’ assets doesn’t make much sense within the context of long-term goals.

Let us now look at the other side of the Treasuries phenomenon. In their quest for certainty, many investors may be unwittingly ignoring dividend yields on stocks, which have become more compelling as a result of the downturn in global markets.

The Dividend Yield

As dividend investors, we have recently noticed that the dividend yield on the S&P 500 Index is greater than the yield on U.S. Treasury bonds for the first time in 50 years!

Case in point, the dividend yield on the S&P 500 as of the end of November was about 3% versus the yield on the 10-year Treasury which today, is about 2% (the 2-year Treasury is yielding about 0.70%). What’s more, this isn’t just a U.S. phenomenon. In Europe, the yield on stocks also currently exceeds the yield on government bonds.

Of course, dividends are a key part of total returns (price appreciation plus investment income, including dividends). The fact that dividend yields are high relative to Treasury yields right now makes the case for dividend-paying companies that much more compelling.

If we look back to the period between 1974 and 1982, the performance of the S&P 500 was sluggish on a price return basis. But if you look at what happened as markets began to recover, including dividends in the returns that investors earned as they emerged from a period of economic uncertainty and capital market weakness (i.e. looking at total return) made a significant difference.

Herding To Safety

Today, the desire for safety runs the risk of driving ‘the herd’ off the edge of the proverbial cliff as people abandon their long-term goals in favor of short-term stability. But despite what the headlines might suggest, the world isn’t two- dimensional.

That is to say it’s not just risky assets or safe assets. To see the total picture, including why dividends need to be a key consideration in the investment process, is a starting point to having better, more robust conversations in today’s uncertain environment.

Comments

[jepittman:]

Mr. McKinna's arguments are good ones. Dividend yields are more competitive than they have been in my memory (I will spare you the exact length but suffice it to say Bart Starr is my favorite pro quarterback). The pressure on investors needing income will inevitably lead them to consider equities. All that is necessary is for the economic news to stop getting worse. The amount of money in the economic bomb shelters is at all time highs. When confidence in risk assets begins to return an awful lot of it will try get through the door at once. It is not hard to imagine what will happen then.

2008 Dec 21 02:34 PM