DJII Should Sizzle This Summer As Bears Scramble For Cover

Despite chronic irrational pessimism weighing on equity markets the DJII does not want to go down. In fact it is near its all-time high and the path of least resistance remains up.

The dividend of the DJII is at a record level and appears very safe now the recent earnings recession seems to be over. Investors seeking yield should look no further than the DJII where the pre-tax yield is 97% of that of the 30 year T Bond, This compares with the long-term average of 48% and a pre-Lehman average of 40%.

Since 1981 the yield of the U.S. 30 year T bond has averaged 2.33 times the yield of the yield of the DJII. Today the ratio of the bond yield to the DJII yield is 1.05. While above the record low of 0.69 reached in the aftermath of Lehman it is very close to the lows of more recent years.

A return to equilibrium or “normal” would require a doubling of either the DJII or the 30 Year T bond yield. The former option seems much more probable than the latter.

It appears that the recent earnings recession is over and a recovery will be underway in the second half of the year. With earnings past their low point and the payout ratio at less than 50% the record DJII dividend is considered safe.

It is possible for the bond-yield to equity-yield ratio to decline further should the yield of the 30 year T Bond fall in response to low and negative international sovereign yields and the much vaunted strong demand for and insufficient supply of new U.S. treasury issues. All of this at a time when there are US$2.3 trillion excess reserves held at the Fed collecting a meager 0.5% per annum.

A steady dividend and falling 30 year T bond yield would push up the relative yield of the DJII. This of course is all pre-tax. On an after-tax basis the returns from the DJII dividend would be that much higher adding greatly to its attraction.

Judging from the outflow of money from equity funds and ETFs, market participants appear to be far too bearish. Indeed one might even argue schizophrenic.

On the one hand there is concern about the Fed wanting to return to a “normal” Fed Funds rates and that all rates will rise and a bear market will ensue. On the other, as the Fed is data dependant raising interest rates implies that the economy is improving and with it earnings and dividends.

While expecting higher interest rates there is a vast quantity of money seeking yield that is prepared to flood debt markets either directly into bonds or into bond ETFs.

An odd thing to do, if higher interest rates are expected. Unless of course, the short-term game is to ride the bond bull and quickly reverse positions jumping to the bond bear in time to enjoy the rides on both. Good luck with that!