Appearing on BNN’s Market Call earlier this week meant I needed to check up on how various indices have been performing year-to-date to put the performance of the stocks being discussed into context. Would you believe that as of the end of the third quarter, 2012, the S&P 500 was up 15.4% year-to-date, the MSCI Emerging Markets Index up 10%, the MSCI EAFE Index up 8.2% and the TSX 60 Index up 4.2%? In other words, all the major stock indices are up between 4% and 15%, against the DEX Bond Index, up a mere 1.2%, yet it is the latter and its US, German, Japanese and UK counterparts that have been receiving steady inflows of investor money, most of it coming out of equity funds.
Over the last year, the contrast is less extreme, with the DEX providing a return of 6.05% againt 6.7% for the TSX 60, 12.1% for the MSCI EAFE Index, 18.9% for MSCI Emerging Markets Index and a remarkable 27.8% for the S&P 500. Yet the relative attractiveness of the two asset classes is clearly tilted in favour of equities, either on the basis of income, where the S&P 500 yields 1.9% and the TSX60 2.7% against approximately 1.7% for the 10 year bond in both countries , or on the earnings yield. This is the inverse of the P/E ratio, and is used to determine the relative attractiveness of equities against bonds, ignoring how much of the earnings are paid out as dividends. The ratio of the 10 year bond yield minus the earnings yield of the S&P 500 is nearly one standard deviation above its 90 year average, making stocks as cheap relative to Treasury bonds as they have been in 35 years.
At a time when the average retail investor has been forced by government and central bank actions to accept yields on supposedly risk free government bonds that are the lowest in 60 years, it seems counter-intuitive that they are unwilling to purchase companies with sound balance sheets that pay dividend yields that are higher than bonds yields in absolute terms. When one adds in the tax benefits of dividends as opposed to interest, and the ability of companies to keep their payouts stable or rising in real terms as they are able to increase dividends, the unwillingness to buy shares becomes all the more remarkable.