What’s Up (Down) With Stocks?

Market breadth breaks a two-year downtrend.

See the chart below? It traces the spread between the 10-year Treasury note rate and the S&P 500 dividend yield. Think of the spread as a leading indicator of stock investor sentiment. Pretty volatile, isn’t it?

Presently, the yield premium offered by the 10-year T-note over stocks is 0.8 percent. All other things equal—and they’re not—the payoff for holding Treasury paper is higher than that for stocks. ‘Twas not always so meager. As you can see, the payoff bonus actually peaked near 1.4 percent in October 2018. 

A strong equity market, together with Fed tightening, bolstered the premium through most of 2018. As stock prices soared, dividend rates naturally shrank. Meanwhile, yields on government obligations were nudged upward by central bank policy, putting pressure on bond values. Then, all that started to unwind in the wake of the November 2018 election. The premium broke below its congestion area and wiped out two years of work before rebounding in January.

So, what happened and why should you care? 

First, the what. History shows that a high yield premium can signal trouble ahead for equity investors, just as a discount, last seen in 2016, portends positive forward stock returns. Last year, the Center for Financial Research and Analysis released a long-term study of the relationship between the S&P 500 and government paper.

Here’s where the why comes in. CFRA found that prospects for future stock gains dim significantly when the Treasury yield premium exceeds 1 percent. Prescient, that. The research report was released just in time to warn stock investors of the trouble awaiting them. You did read the report, didn’t you? And acted accordingly? 

So now the yield premium’s under 1 percent again. Did the market just blow off excess steam? Does that rebound on the chart signal another round of speculative buying ahead? There’s a clue in another chart.

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Disclosure: None.

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