A Historical Look At Dividend Yields and Stock Prices

By DoctoRx

The chart below is a chart of the dividend yield on the S&P 500 (or a synthetic version of such before the modern version began in 1950. This courtesy of the excellent site multipl.com.

The above chart is for those many people who won’t buy a Treasury or high-grade corporate bond . . .

And, for comparison, below I show a chart of the Dow from Yahoo’s finance section.

(The ’500′) has a shorter history than the Dow, but directionally the two indices have moved together. Please note that the starting dates for the two charts are different. You may wish to look at minima and maxima in the Dow versus maxima and minima in the dividend yields above.

Even though bonds are very richly priced today (i.e., have low yields), stocks pay one even less to own them with less security of principal once one goes out several years. 

The first chart shows that historically, a 3% dividend yield on the ’500′ was a “sell” signal. Perhaps we have entered a new era of low dividend yields. If so, is it reasonable to suppose that periodically, a rise to 3% yield becomes a buy signal, whereas periodically it was considered too low to take the risk of owning stocks? That concept appeals to at least my view of symmetry. If that view appeals to you, you may wish to compute how fast dividends need to rise if the averages stay unchanged to reach that 3% yield level, or else how far stocks need to fall to reach 3% if the fall occurs with an unchanged dividend payout.

Investing is all about return of principal plus return on principal. High-grade bonds guarantee (more or less) the first but stocks do not, and currently a 10-year high-grade muni bond yields on average 2.78% each year for 10 years free of tax, and then one gets a do-over with the money. Meanwhile, a projected average dividend yield for the ’500′ over the course of 10 years is about 2.2%, which is taxable.

I’m not a doomster. I’m not predicting the end of the financial world. I don’t expect the apparent fact that large sums of bad loans were made to various countries in Europe, and elsewhere, to have a long-term effect on US and global commerce. In the shorter term, though, I haven’t a clue as to what is already priced into various markets. Not only am I not predicting a new depression, as many pundits and bloggers do to scare people into gold or bonds or cash and out of stocks, I think that the depression that began in 2007 is probably burning itself out but that we are probably not ‘there’ yet.

I simply think that adjusted for risk, US stocks are overpriced given the phase of the economic cycle the US is at and that most people and pension funds remain overweighted in stocks and underweighted in precious metals, especially gold and gold stocks.

See the original article >>