Dividend Stocks: Watch Those Yields

Equity markets are down, which means that dividend yields are up.

It's a fundamental relationship, and one that endures. No wonder, then, that a growing body of academic research (and a healthy dose of common sense) counsels that the relationship produces valuable clues for strategic-minded investors. In short, raise equity weights when yields are relatively high, and trim that exposure when yields are relatively low. Ideally, such shifts are done gradually, over time, to manage the risk that no one really knows if current yields will remain the apex, or trough, for the cycle.

There are other factors to consider in managing portfolios, of course. For the moment, however, we'll focus on dividend yields, which are up these days, as our chart below shows. Indeed, some corners of the world's equities markets are sporting rather attractive yields, relative to recent history.

Europe leads the way among the globe's major regions, posting a 4.35% yield (based on the trailing 12 months) as of June 30, 2008. (All data is via S&P/Citigroup Global Equity Indices.) How high is 4.35%? It's the highest in at least 13 years. After factoring in the selling so far this month, the current trailing yield is almost certainly a bit higher today.

By comparison, the U.S. trailing yield is quite a bit lower at 2.0%, although relatively speaking that's close to a new high based on data since 1995. And if we consider the continued selling this month, we may already at a new high in yields in the U.S. market generally.

Meanwhile, developed markets in Asia are at a new post-1995 yield high, as is the developed-world equity market ex-U.S.

It's a different story in emerging market stocks. As our second chart below reveals, yields are still middling relative to the their history since 1995, ranging from 1.38% for Latin America up to 2.65% emerging Asian markets, as of June 30. Of course, one might argue that the allure of the emerging world is the growth potential rather than its yield capabilities, and so dividends aren't all that important here. Perhaps, although for the moment there's not much growth in share prices anywhere and so dividends are a lone bright spot.

In the long run, dividends do matter, at least for a broadly diversified portfolio. No one should buy, or sell stocks solely because of dividends, of course, or any other single metric. But neither should strategic-minded investors ignore the income stream produced by stocks. Indeed, when equity yields move to extremes, the associated signals about prospective returns are more reliable. History, at least, tells us so.

The eternal question, of course, is whether we can accurately identify extreme levels in real time. Inevitably, that's a speculative task and prone to error. Nonetheless, it's clear that in some markets we're quite a bit closer to the extreme than we have been in quite a while. As a result, the odds have improved for buying now in anticipation of receiving relatively higher total returns over the next five years-plus compared with buying six months ago.

That doesn't mean that yields won't be even higher down the road, or that buying today insures a profit as of, say, July 10, 2013. The future is always unclear, and that introduces risk. But at least we have some clues about what's coming, a message that boils down to the basic lesson that Ben Graham taught us all those years ago: Valuation matters.

Comments

[proseadvocate:]

The only comment I have, which should be addressed, is the ease with which dividends can and are being cut when they become exagerated, e.g., 15% yield on Barclays can't last much longer.

2008 Jul 10 10:51 AM

[fatcat:]

It's the old dividend trap.You just about have to take most of the financials out of the mix,then what have you got?

2008 Jul 10 11:10 AM

[Umm, yeah:]

@fatcat

You're probably left with a lot of energy and commodity stocks, whose dividends will drop if their underlying commodity falls in price...

2008 Jul 10 02:14 PM

[optionsgirl:]

How about the Canadian Royalty Trusts? Great dividends, but you do have to pay foreign tax...

2008 Jul 10 04:10 PM

[avante@yahoo:]

Dividends on the financials are by any standards very high.
If the large banks cut their dividends by any major amount they can expect,and rightly so a further major exodus by the retail public from their shares. While the people who gave us this "crisis" are aware of this they may take the "easy" way out. It took years to get the investing public back into the market.They will be playing with fire.

2008 Jul 10 04:27 PM

[icandoitdon:]

the head of BAC has repeatedly stated, and stated again in the couple of days, that they will not cut the dividend nor issue additional capital. but when you look at the share price (off 60%+) and the yield (11%+) the market is calling him a liar.

lying is a way of life for too many CEOs. it will be interesting to see this one stays true to form.

2008 Jul 10 04:34 PM

[notsosmart:]

lying is the way of american life. no one is held accountable from the pres. to the congress down to our students.greed & lack of ethics now go hand in hand with capitalism. honestly-who can you believe? think about it.

2008 Jul 11 11:13 AM

[richandmer:]

There is a Dividend Aristocrats and Dividend Champions for U.S. stocks that list the stocks that have increased dividends every year for 25+ years. Does Europe have a similar list?

2008 Jul 11 04:06 PM