What Are These Yields Telling Us?

Category: Blog

One wishes to tread very lightly here.

That’s because one is looking at something he has never seen before, and trying to figure out what (if anything) it should mean to the long-term, goal-focused, planning-driven investor. Please take what follows in just that spirit of inquiry.

The relevant facts are as follows:

  • As I write on this 33rd anniversary of Black Monday 1987—October 19th—the current yield on the 30-year U.S. Treasury bond is 1.564%, according to Bloomberg. Can we just call it 1.6%?
  • It may seem counterintuitive in this plague year, but data from Bloomberg indicate that the total dividend payments from the constituents in the S&P 500 Index will come to an estimated
    $59.41 per share in 2020, up from $58.69 (the previous record) in 2019. Can we just call it $60?
  • The S&P 500 opened this morning a tad below 3,500. Assuming the $60 dividend number above, then, the Index is currently yielding 1.7%.

In sum, an index of 500 of America’s largest, best-financed, most profitable, most innovative businesses currently yields more than does the 30-year sovereign debt of the United States.

I’ve never seen that before. I can further report that it has never happened in my career as a financial professional, which began in 1967. In that time, the 30-year Treasury has always had a higher current yield than stocks—sometimes a lot higher. That’s just logical. It’s because stocks offer precisely what bonds do not: significant potential for growth, both of capital and (via dividend increases) income over 30 years.

If a new 30-year Treasury were being offered today, and I bought it, my prospects over the next 30 years would be as follows. Believing as I do that said bond is the highest-quality long-term debt instrument ever crafted by the hand of man, I would be virtually certain of getting my (taxable) 1.6% annual interest, and at maturity I’d get back my principal—that is, the $1,000 per bond I’d invested 30 years earlier.

But in the next breath, I note two cautions. (1) The central bank of the United States—the Federal Reserve—has a clearly stated policy goal of engineering two percent inflation. Should they achieve this going forward, the purchasing power of my cash income would actually be declining at a rate greater than my percentage yield. After tax, my real return would be solidly negative. (2) At the long-term (1926–2019) inflation rate of 2.9%, as reported by Morningstar/Ibbotson, the purchasing power of the $1,000 per bond I’d be repaid in 30 years would have fallen to about $400. Another way to say this is that my capital would have lost 60% of its purchasing power.

If instead I chose to invest in a security that tracks the S&P 500, I’d be guaranteed absolutely nothing by absolutely nobody. Instead, I’d be thrown back on history, and on my own tolerance for ambiguity. There are simply no facts about the future.

In trying to decide whether to own the equities or the bonds for the next 30 years, I suppose I might begin by consulting the equity experience of the last 30 years or so—let’s say 1990 to now. According to NYU Stern School’s “S&P 500 Earnings History,” the Index ended 1990 at 330.22; that year it had paid dividends of $12.09. As we’ve observed, the current price of the Index is around 3,500, up more than 10 times; the dividend, as we saw, is running at a rate of about $60, up virtually five times. Both increases compare very favorably to the Consumer Price Index, which—per InflationData. com—is up just less than twice.

Of course, the next 30 years won’t precisely mirror the last 30; they never do. (At least I hope they won’t, when I remember that the 1990–2019 period takes in the two deepest bear markets in equities since the 1929–32 experience. Thus, even as the Index was appreciating 10 times, it managed temporarily to fall 49% in 2000-02, and a whopping 57% in 2007–09. Yikes.)

I think you see where this is going. (Heck, it’s already there.) How does someone investing for the great goals of life—a se- cure retirement over perhaps three decades, meaningful legacies to loved ones—buy bonds at today’s interest rates, in preference to a broadly diversified portfolio of high-quality equities with a startlingly competitive current yield? Of what is one so afraid that he would invest for what will quite possibly be—after inflation and taxes—a negative real long-term return? I confess I just don’t see it.

This is no more than one man’s opinion. Or, more accurately, one man’s take on what appears to be a significant financial anomaly. I’m surely no less a prisoner of my experiences and biases than is anyone else. But as you work to make intelligent, long-term, goal-focused investment strategy in 2021 and beyond, this may be something you and your financial advisor will wish to consider.

© November 2020 Nick Murray. All rights reserved. Used by permission.

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