Santoli: Bond-like yield may support tired bull

Published Mon, Mar 14 20168:40 AM EDT

Dividends are becoming a crucial source of investor income for the same reason the Colorado River became a vital source of water for Los Angeles a century ago: because other options dwindled and thirst is never sated. With central banks of the world's mature economies suppressing short-term interest rates near or below zero, safe yield is gravely scarce on the planet. Yet dividends from big American companies have grown along with corporate profits, and in aggregate now equal just about the total interest paid on public bonds by U.S. issuers. The dividend yield on the Standard & Poor's 500 index is now at 2.2 percent, a hair beneath the yield on the Barclays U.S. Aggregate Bond Index, a nearly comprehensive benchmark of government, mortgage and high-grade corporate debt. As the table here shows, it now happens that the market value of the S & P 500 and the total assets underlying the Barclays U.S. Aggregate are roughly equal near $17 trillion. This means the total dollar amount dispensed by the bond market and by large companies as dividends is about the same, just under $400 billion annually, making dividends an indispensable source of yield for everyone in the system, including aging individuals struggling to meet an income target on their savings. The scarcity of yield is even more pronounced than these broad numbers suggest. After its quantitative easing program of asset purchases, the Federal Reserve holds $2.5 trillion in U.S. Treasurys and $1.8 trillion in agency-mortgage bonds. Commercial banks hold another $2.2 trillion in Treasurys. So the pool of indexed-bond yield available for the public to earn is even shallower than that $399 billion shown. Central bank warehousing of bonds is intended to compress borrowing rates but also to lift the value of riskier assets such as stocks. The European Central Bank will now begin buying corporate debt along with government paper. The Bank of Japan buys equity exchange-traded funds already. The mechanism for this goal has commonly been described as "forcing" investors to take on more risk, though of course investors can choose instead to earn even less at the bank. But there's no doubt that it has squeezed plenty of otherwise risk-shinning investors into stocks mostly for the dividend income. Read More Pro Strategy: Fitbit may outrun the shorts The five largest dividend-focused ETFs together have around $64 billion in assets — more than the Vanguard Total Stock Market fund (VTI) or the Nasdaq 100 (QQQ). It's now common to read personal-finance experts counseling retirees to own blue-chip stocks for part of their income needs. Because dividends grow over time, stocks can look like a great deal for long-term income investors in hindsight. Yardeni Research notes that an investor who bought the S & P 500 at year-2000 prices now enjoys a yield of 3.2 percent, due to rising payouts. The "yield" today for a buyer in 1990 is a whopping 13.1 percent. Since the October 2007 market top, the S & P 500 market cap is up 29 percent but the total dividend payout is 58 percent higher, leaving an unlucky buyer of the market that month with a 2.8 percent yield on that investment. In some ways, this income-centric view of stocks is a return to the pre-1960s mindset, before growth of capital became the game. Still, feeling compelled to assume equity-market risk in exchange for some income is an uncomfortable position for many investors — at least for those who understand that the principal value of their shares can swing dramatically over short time periods, and shouldn't be viewed as true substitutes for bonds in a portfolio. On some level, the thirst for income could place a firmer bid underneath the stock market than might otherwise be the case — at least in the sectors favored for by dividend "coupon clippers." It's notable that the overall S & P 500 dividend yield has been quite flat during the entire bull market, around 2 percent. As the market has climbed since 2009, dividends have as well. Whenever the dividend yield has risen significantly above the 10-year Treasury yield (as it has again early this year), stocks have recovered off their lows before long. Read More Risk assets about to top: Strategist As a result, though, many stocks and sectors prized for their steady income potential have become — and could remain — rather richly valued, leaving little room for much appreciation. Utility stocks fetch historically high multiples of earnings, as do consumer staples stocks and other steady businesses. Procter & Gamble last year paid out 70 percent of its net income in dividends, a key reason the stock retains a price-earnings multiple above 22 despite meager fundamental growth. Similarly, Waste Management has made it a strategy to turn garbage into generous dividends, attracting a loyal retail investor base and a 21 P/E despite failing to grow revenue by even 3 percent a year. The extreme cases are in Big Oil, where the zeal of companies like Chevron to sell assets and cut capital spending and take on debt to maintain a dividend has become a crusade. Chevron failed to earn its dividend last year and won't even come close in 2016. This mechanical hunt for dividend streams won't in itself drive the market higher or rescue the tape single-handedly in a serious economic downturn. But so long as yield remains scarce, people will go to more trouble and expense to get it, likely making assets with access to the precious resource more valuable than those in more arid stretches of the market.

A trader works on the floor of the New York Stock Exchange.

Brendan McDermid | Reuters

With central banks of the world's mature economies suppressing short-term interest rates near or below zero, safe yield is gravely scarce on the planet. Yet dividends from big American companies have grown along with corporate profits, and in aggregate now equal just about the total interest paid on public bonds by U.S. issuers.