Great News for Investors: Stocks Yield More Than Bonds

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Something rare and wonderful happened last week: The average dividend yield on the 30 Dow Jones Industrial stocks surpassed the yield on the 10-year Treasury bond. As I write, the average Dow stock yields 3%, while the 10-year Treasury yields 2.93%.

Why you should care
Since stocks provide the possibility of growth, investors are typically willing to pay a premium over bonds. When investors think future growth will be strong, the spread widens. When they're expecting a slowdown, it narrows.

Right now, the spread is negative. What this means is pretty straightforward, and falls into one of three possibilities:

  • The market thinks dividend payouts will fall over the next decade.
  • Volatility's beaten the market into submission. 
  • The market is a deranged lunatic, and stocks are cheap compared with bonds.

Depending on how you look at it, this is either terrifying or fantastic news. Terrifying in that market is predicting an awful 10 years; fantastic in that it proves how utterly fear-stricken investors are.

For historical context on this issue, the best guide is Yale professor Robert Shiller's collection of market data dating back to the late 1800s. I truncated the data down to 1925-today, since markets have developed and matured so much that comparing today to the 1800s isn't terribly useful.

Digging through the data, a couple points stand out:

  • Since the late 1950s, equities have nearly always commanded a spread premium, with bonds yielding 3.8% higher than stocks on average.
  • The Great Depression in the 1930s is the only modern period where dividend payouts fell over various 10-year periods. From 1930-1940, S&P 500 dividends fell by roughly one-third. Dividends' average compound annual growth rate from 1925-2006 was 4.6%.

That said, today's market prices imply that the next 10 years will be the worst time for corporations since the Great Depression, and unimaginably worse than other wretched periods such as the mid-1940s and the 1970s.

The market that cried wolf
Could that happen? Sure it could. Whether you should actually bet on it happening is another question. And as hard as it may be today, I wouldn't. The last few years have been hellish, yet S&P 500 companies are paying higher dividends today than they were in 2006. Corporate America is a resilient beast.

If you think today's market is correctly predicting the future, here's a game to play: Ask yourself how often the market has accurately predicted the future 10 years hence when prices imply outlying future returns (in either direction). Or even five years hence, for that matter. Their track record is pitiful. When markets predict neverending booms or perpetual busts, they're almost invariably wrong. Try debating that.

Fear and greed control markets short-term, after all. When the spread hit negative 10.3% in 1932, the market was shouting from the rooftops that investors should flee stocks and hide in bonds. Stocks then nearly quadrupled over the next five years. When the spread hit 5.3% in 2000, the market was begging investors to go all in. You know what happened next.

If history is a guide, today's negative yield spread is a bullish sign for stocks, and bodes ill for bonds. Of course, that's exactly the opposite of what most investors have been doing over the past year, with bond inflows outpacing stock inflows by magnitudes. Past returns mixed with fear make people do funny things.

Follow the money
Want to take advantage of what the market is serving up? Consider that several members of S&P's Dividend Aristocrat Index, which S&P describes as companies "that have followed a policy of increasing dividends every year for at least 25 consecutive years," yield considerably more than 10-year Treasurys' yield of 2.93%.

S&P Dividend
Aristocrat Member


10-Year Dividend
Growth Rate

Eli Lilly (NYSE: LLY  )



Kimberly-Clark (NYSE: KMB  )



Abbott Labs (NYSE: ABT  )



Johnson & Johnson (NYSE: JNJ  )



Coca-Cola (NYSE: KO  )



ADP (Nasdaq: ADP  )



Source: Capital IQ, a division of Standard & Poor's.

Gloom is rampant. Profits are at new highs. Dividends are higher most other income alternatives. Call me nuts, but it looks like stocks are a better buy today than they've been in a while.

Fool contributor Morgan Housel owns shares of Johnson & Johnson. Coca-Cola is a Motley Fool Inside Value selection. Automatic Data Processing, Johnson & Johnson, Kimberly-Clark, and Coca-Cola are Motley Fool Income Investor choices. Motley Fool Options has recommended buying calls on Johnson & Johnson. The Fool owns shares of Coca-Cola, and has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 07, 2010, at 6:07 PM, TheDumbMoney wrote:

    I wonder to what extent the markets are pricing in the expected increase in the tax on dividends (and capital gains) when the tax cuts expire. I also wonder to what extent this is a phenomenon I choose to label "hysterical, ideologically-motivated market fear" (inspired by pretty much everything Larry Kudlow has ever written or said), given that many of the best companies had paid increasing dividends for years and years and years before the tax on (U.S. companies') dividends was cut to 15%.

    Also, when you tease out the assumptions people are making when buying treasuries at 2.X%, versus buying shares for the long term in JNJ or KO (or IBM, etc., etc.), it almost seems to me at least that we should EITHER be buying JNJ/KO/IBM..., OR buying seeds, MREs, guns, bullets, and water purification tablets..., but in any event, NOT buying the treasuries, or for that matter almost all bonds. But that's just me!

    Anyway, loved this. Thanks.

  • Report this Comment On July 07, 2010, at 7:21 PM, ChrisBern wrote:

    I wouldn't attribute a whole lot of value, though, to comparisons with current U.S. bond yields. The reason these yields are so low is because nobody knows where else to store their money safely.

    Long-term objective measures of the S&P 500 (e.g. Robert Shiller's PE10) still show it over-valued, DESPITE the major headwinds coming against it.

    An interesting note: the average monthly closing price of the S&P 500 in 1932 was $110.90. The average closing price a decade later, 1942? $116.00. With plenty of buying opportunities in between.

  • Report this Comment On July 07, 2010, at 7:33 PM, CMFStan8331 wrote:

    "Past returns mixed with fear make people do funny things."

    I think that's it, in a nutshell. If the whole world economy does suffer a nuclear meltdown, there won't really be anywhere to hide no matter where you may have invested your money. If our entire civilization does come crashing down, I'm not convinced that the bunker folks will really end up being much better off than the rest of us.

    What we're seeing right now reminds me of the tech boom, in reverse. It's a melt-down boom. Anyone wanting to bet long-term economic distress is paying a HUGE premium. Obviously we do have many problems, but I'm putting my money on the possibility that current economic conditions will not lead us into another Great Depression.

  • Report this Comment On September 18, 2010, at 10:24 AM, nicklukecal wrote:

    Look, "Buy and Hold" is dead (for now anyway). Trying to guess the markets direction is a fools (small f) game. Especially now. Therefore, trade the chart in front of you. Find stocks in an an uptrend, apply some rules that get you in and out when you profit or lose, and repeat. Fortune favors the engaged not the lazy.

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