It's looking rather gloomy out there. The S&P 500 is down 41% year to date, led by the financial sector, which has lost more than half its value. Energy is down 37%, technology is down 46%; even the best sector of 2008 -- consumer staples -- is "only" down 19% year to date.
But there are two reasons why this is a great time to be investing in the market.
Add it up
Amid all the doom and gloom, one little-known silver lining hasn't been getting much attention: Dividend yields are the highest they've been in years.
Seventeen years, to be precise -- the recent market plunge has increased the dividend yield on the S&P 500 to 3.4%, its highest level since June 1991.
Not even during the aftermath of the tech bubble collapse in the fall of 2002 -- when the S&P 500 traded at 815 -- did the yield break 2%.
The increased yield is even more impressive when you consider the following facts:
- 10% fewer companies paid dividends in 2007 than paid them in 1995.
- Companies are returning money to shareholders through other means, such as stock buybacks, which more than quadrupled since 2003.
- The $589 billion spent in 2007 to buy back shares is more than double the $246 billion paid out in cash dividends the same year. For example, Eggo frozen waffle maker Kellogg (NYSE: K) repurchased $650 million worth of stock over the last fiscal year, more than the $475 million it paid out in cash dividends.
- Financials, which have historically been the biggest dividend payers, comprising 16% of the index but paying 25% of the dividends, have been cutting their payouts. Prudential Financial (NYSE: PRU) is a case in point, slashing its quarterly dividend from $1.15 to $0.58 per share.
Some of our most well-known blue-chip stocks, like AT&T (NYSE: T) and Wells Fargo (NYSE: WFC), currently sport respective yields of 5.8% and 4.7%. That's even greater than the S&P 500 average.
An unexpected disparity
But high dividend yields aren't the only reason this is a great time to be in the market -- stocks are also cheaper than trusty bonds.
The 10-year Treasury bond currently yields 3.7%. The equivalent measure of return for stocks is the earnings yield (earnings divided by price) -- and it currently stands at 5.7% for the S&P 500.
This divergence is unusual, and a potential boon for investors. According to renowned value investor Arnold Van Den Berg of Century Management, (whose firm returned 13% net of fees vs. 6% for the S&P 500 over the past 10 years),
The usual difference between a bond yield and stock earnings yield is about 1%. For example, if investors can get 6.3% on a guaranteed bond they are willing to accept 1% less, or a 5.3% earnings yield on a stock. The reason for this is that if you have a 5.3% stock earnings yield and it is growing at 7%, it will equal your 6.3% bond yield in about 3 years. Anytime thereafter, the stock earnings yield will increase by 7% per year.
Investors are usually willing to accept a lower yield in stocks because of the presumption of future growth. Right now, however, investors can get that growth at a better price than bonds -- and with the added bonus of high dividend yields.
Earnings yields like this suggest that the market thinks earnings are likely to fall. But I would counter that even if they did, the S&P 500 still would yield an almost equal amount as Treasury bonds.
A good time to buy
The combination of high dividend and earnings yields relative to bond yields means that this is a great time to buy dividend stocks. They're also solid bets for a bear market.
There are a lot of good avenues to research further. Pharmaceutical groups Sanofi-Aventis (NYSE: SNY) and GlaxoSmithKline (NYSE: GSK) shares both yield more than 5%. Drugmakers are recession-resistant, and they should provide your portfolio with some immunity to financial market turmoil. Fools might also consider diversified conglomerates such as Siemens (NYSE: SI), which is down more than 65% from its 52-week high, and currently yields 3.4%.
At Motley Fool Income Investor, we believe in the power of dividends to create unbeatable long-term returns. Our recommendations have an average dividend yield of 7.7%, and they're outperforming the market by four percentage points.
Interested in adding a few dividend powerhouses to your portfolio? You can see all of our recommendations, as well as our best bets for new money now, with a 30-day free trial. Click here to get started.
Fool analyst Andrew Sullivan loves dividends, but he does not have a financial position in any of the stocks mentioned in this article. GlaxoSmithKline is a Motley Fool Income Investor pick. The Motley Fool has a disclosure policy.
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