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Historic Yield Spreads Between Stocks and Treasuries

The financial press is full of comments about the historic level of interest rates, and the appeal of dividend income, both as a partial alternative to bonds and for income growth.

Even though high quality, large-cap stocks with strong business franchises, above average yields and a history of sustained dividends and dividend growth will fluctuate widely in price, the dividend stream is less volatile.

This letter presents the current spread between S&P 500 "as reported" earnings yield and 10- year Treasuries, as well as the spread between S&P 500 dividend yield and 10-year Treasuries over a long period of time.

Right now, using trailing 12-month actual "as reported" earnings, and paid dividends relative to today's S&P 500 price, and today's 10-year Treasury rates; stocks look quite attractive. That is attractive on a yield relative basis. There is nothing at all attractive about the price behavior of the S&P 500 today or recently. However, the longer-term argument for stocks and dividend stocks is building. Treasury rates will rise, but when is a difficult guess.

Treasuries today produce negative real returns (nominal yield less inflation), and that is before taxes. High quality, above average yield stocks produce positive real returns at this time, and have produced real growth in the past and presumably in the future. Bonds do not produce any growth in income.

The earnings yield today, using the data described above, is 7.13% for the S&P 500. The dividend yield is 2.04%. The 10-year Treasury is 2.07%. High quality dividend stocks can be found with dividend yields of 3%, 4% and some even 5% or more.

The S&P 500 earnings yield spread to 10-year Treasuries is unprecedented in 30 years. However over 140 years from 1871 the earnings yield spread was more than 5% in 19.6% of the months. Still a 1 in 5 opportunity is interesting.

The dividend yield spread to 10-year Treasuries is negative 0.03% (dividend yield almost equal to 10-year Treasury yields, but with the prospect of income growth which is not possible with bonds). Additionally, odds not only favor dividend growth over the next 10-years, but odds favor 10-year Treasury rates rising over the next 10-years. Rising rates would reduce the value of 10-year Treasuries acquired today (in addition to negative real return before taxes, Treasuries create an extra negative real return after taxes).

Dividend stocks deserve a role in conservative portfolios, and perhaps others.

S&P 500 Earnings Yield Spread to Treasuries

Monthly Spread: S&P Index Earnings Yield Minus 10-Yr Treasury Yield (30 years through Q1 2011)
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Monthly Spread: S&P Index Earnings Yield Minus 10-Yr Treasury Yield (1871-Q1 2011)
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Monthly Spread: S&P Index Earnings Yield Minus 10-Yr Treasury Yield (30 years through Q1 2011)
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Monthly Spread: S&P Index Earnings Yield Minus 10-Yr Treasury Yield (1871-Q1 2011)
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