risk to equities of higher bond yields
The risk to equities of higher bond yields is
that it will dampen the bond proxy trade. That is,
money that has moved from bonds to equities
with reliable dividends and seen as a substitute
to investors struggling with low bond returns.
To illustrate, before the financial crisis, ten-year US
treasuries yielded about four per cent. That was
two-fifths more than the dividend yield on the
dividend aristocrats, and double the broader
market.
Since then, falling bond prices mean the
aristocrats now yield 2.2 per cent, only slightly
below the ten-year bond yield, and noticeably
above the two-year yield. That raises the spectre
of the problems discussed above.
So while equity investors remain fixated on
the market’s valuation relative to earnings, it is
the dividend bubble quietly inflating in the
background that should be of far greater
concern.
It is an ever rising dividend policy that
so many investors have placed their faith and a
company’s earnings power has become a
secondary concern. These priorities are wrong
and it is only a matter of time until there is a
correction. Given the changing macro backdrop
in 2018, that could occur sooner than expected.
EU Forecast
euf:b18:157/nws-01