Looking for yield in all the wrong places

There is a big difference between dividend yield in stocks and the contractual yield inherent in bonds. But something interesting happened recently. The dividend yield on stocks fell below the contractual yield of the 10-year Treasury note.

More accurately, the yield of the 10-year Treasury rose above the 2% yield on the Standard & Poor’s 500 Stock Index. For investors, the yield’s rise above 2% represented a big crossover moment, which we have not seen since April 2012.

When this crossover moment occurred, volatility began to rise and stocks pulled back from their upward trend. Dividend-paying and defensive stocks began to fall behind in terms of performance. It's no wonder that bonds began to look more attractive than stocks for the first time this year. A contractual stream of coupons from a government like that of the United States seems a lot more certain than a dividend yield on the stock market that has no promises attached.

Many investors have been mining for bond equivalent yields in stock markets. We know this because in the first five months of this year we witnessed defensive, or noncyclical, and high-yield stocks outperform the rest of the market. Clearly, investors were frustrated with continued low yields on savings accounts and bonds. With yields over 2%, the trend is beginning to change. Defensives have seen their performance decline, partially because investors can now get a higher yield from bonds than from stocks.

So, I need to remind investors that it is a much better strategy to look for cash flows, and not dividend yields, in the stock market.

Investors have been disappointed time and time again by seeking yield proxies. We believe yield is an important part of stock market investing, but we have never advocated the chase for the best or highest yields. The only yield-chasing that makes sense is deliberately sifting through the stock market for the best companies with the most promise and the best chance of growing cash flow from operations. To find those companies one needs to learn about the products, the competitive pricing of those products, the cost structure of the company, and the management. That is not an easy task, but those companies do exist, and time and history have shown that dividend yields, backed by solid and secure growth in operational cash flow, can and do make a difference to investors.

No forecasts can be guaranteed.

The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.


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