The Independent Market Observer

Back to the Future in Risk and Return?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jun 29, 2012 2:07:42 PM

and tagged Debt Crisis

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Back in the day, I understand, stock dividend yields were higher than bond returns. They had to be, you see, because stocks were so much riskier that investors demanded the return premium. Gentlemen preferred bonds.

When the yields crossed—when bonds, especially Treasuries, started yielding more than stocks—people said that it was a one-time event, that it couldn’t last for an extended period of time. Dividend yields lower than Treasury yields? Ridiculous! Many waited to buy equities until the inevitable correction, knowing that with dividend yields in excess of Treasury yields, a correction was coming. And they were right, or close to right, the first couple of times that the yield lines crossed. In the early 1960s, the last time they were close, they thought the smart move was to wait again for the inevitable correction.

It was a long wait, until 2008, as shown in the chart. When the yield lines crossed again, the reaction was exactly the opposite but exactly the same. Dividend yields higher than Treasury yields? Ridiculous. A one-time event, a crazy risk-off trade said the (younger) market participants. Equities should always trade for a lower dividend yield than bonds, as they have so much more growth potential!

And they were right, until the next time the yields crossed, in 2012. Again, a result of one-time factors—well, two-time, perhaps. Risk aversion. Europe. The Fed manipulating interest rates. Something! It is unthinkable that dividend yields could exceed Treasury yields for an extended period of time. Many are waiting for the inevitable correction when Treasury yields increase and dividend yields decline.

The Fed has committed to maintaining interest rates at very low levels for the next couple of years. The economy appears to be slowing again, and in any event, the high level of slack means that inflation is not an immediate problem. Corporations are either increasing dividends or starting to do so to appeal to an investor base that is increasingly both more risk averse and more focused on income—and the baby boomers are not getting any younger.

Ridiculous? Maybe not.


Government bonds are guaranteed only as to timely payment of principal and interest, and if held to maturity, offer a fixed rate of return and fixed principal value. Government bonds do not eliminate market risk. The purchase of bonds is subject to availability and market conditions. There is an inverse relationship between the price of bonds and the yield: when price goes up, yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income.

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