For the first time in 50 years, the dividend yield of the S&P 500 is greater than the yield of the 10 year Treasury Note. Until 1958, the dividend yield was always higher than the Treasury yield and the rationale was that stocks were riskier than bonds and therefore investors required a higher yield to hold them. That’s just another way of saying that investors demanded a higher risk premium to own stocks.
Why is this happening now (via MarketWatch)?
Cliff Asness, however, thinks he has come up with some clear answers. He is managing and founding principal at AQR Capital Management, a Greenwich, CT-based quantitative research firm. In the March/April 2000 issue of Financial Analysts Journal, Asness argued that neither the pre-1958 period nor the decades since are anomalous. On the contrary, he found that — below the surface — stock and bond yields have always been strongly positively correlated. Read Asness’ article.
The reason that this strong correlation was hidden, according to Asness, is that investors’ expectations have changed of the relative volatility of stocks and bonds. Prior to the last 50 years, investors expected the stock market’s volatility to be much greater than bond market volatility. To entice investors to incur that greater volatility, the stock market had to provide a higher yield than bonds.
These expected relative volatilities changed early in the post-war period, according to Asness. And that is why — beginning in 1958 — the stock market’s yield dropped below that of bonds, and stayed there for five decades.
The situation has reversed itself in recent months, according to Asness’ theory, given stocks’ extraordinary volatility.
That’s still another way to say that the risk premium has risen. If stocks remain volatile, investors will likely continue to demand a significant risk premium to hold stocks. Attitudes take a long time to change but when they do, they are hard to reverse. Have attitudes about the stock market changed that much? I don’t think so, but if the volatility continues for much longer, they could.