What is yield support?
It’s a notion that was prevalent in the Eighties and earlier, back when the S&P had a long history of significant nominal dividend yield. The idea is that, in a downturn, the fall in the market as a whole–and in dividend-paying stocks in particular–will be cushioned by the fact of continuing dividend income. At some point, the argument goes, a 4%-5% dividend yield means “you’re being paid to wait” for earnings to recover. This current income means you can buy the stock sooner, and at a higher price, than you would without the dividend. Therefore, the price never gets to the level of the most bearish prediction.
In the old days dividends were important enough as a component of total return that a famous Wall Street strategist sounded a stern warning in the mid-Eighties that the stock market was about to collapse. His reason?–the dividend yield on the market had broken below 3%. He had charts showing that this had occurred only a few times in the post-WWII era, and then only for short periods. Every time, the market had soon entered a severe correction.
Unfortunately for this prediction, and for this guy’s career as a strategist, the stock market powered ahead from that point for fifteen more years. The dividend yield on the S&P steadily declined to around 1%, returning to the 3% level only during the 2008 market decline .
What went wrong? What didn’t he see? I think the most important factors were:
* investor preferences changed. Baby Boomers wanted capital gains, not dividend income.
* this allowed younger, more capital-hungry companies (who wouldn’t pay any dividends) to list, changing the composition of the market.
* disinflation raised the real value of even a static nominal dividend (the story of consumer staples and utilities in the Eighties).
“Paid to wait” is the operative phrase now
Here we are in 2009 with the S%P as a whole yielding 3%, about the same as the ten-year bond, and with maybe a quarter of the S&P yielding over 5%. What makes this figure more striking is that, aging tech giants to the contrary, the S&P isn’t chock full of no-growth, bond-proxy, income-oriented companies.
We’re not back in the Eighties, either. For one thing, the Baby Boom is twenty some odd years older, and presumably more interested in income now. Also, given how low interest rates are today, stocks probably have better total return protection against a cyclical rise in rates than bonds. This just makes the failure of dividend yield to support the market more stunning.
How can the yield be so high? The only reason I can come up with is that we’ve gone for such a long period where dividends were irrelevant to mainstream investors that the market has forgotten how to analyze dividends.
Where to we go from here? In the short term, no one knows. But I don’t think we stay at these yield levels for long. And I think the issue disappears by stock prices going up. That’s why “you’re being paid to wait” has become relevant for the first time in almost 25 years.
The biggest risk I see is the possibility that corporate directors have paid as little attention to dividends as investors have in recent years. When dividends mattered more, I think company boards were very careful to stress test their dividend decisions and set payouts at levels that would be amply covered by cash flow (yes, dividends are supposed to be paid from profits, but I think the correlation with historical cash flows is stronger), even in a deep cyclical downturn. A look at historical sources and uses of funds should help decide the issue.
I have an explanation, albeit simplistic, for the “disappearance of yield support” as a stock market consideration. It was the sweeping, if temporary U.S. global domination starting in 1991 after the victory in the Persian Gulf War and the collapse of the Soviet Union. These events sent the U.S. markets to unprecedented valuation heights for the better part of two decades. They returned to “normal” (i.e. pre-war) levels, briefly in late 2008-early 2009, but have since rebounded again to levels reflecting an earlier political supremacy that is being chipped away day by day. A similar sequence of events played out after World War I, to the early 1930s.