S&P 500 Negative Total Real Yield

In an increasingly complex and uncertain financial landscape, investors are constantly searching for those waypoints that will help guide and inform their investing decisions. Among a confusing variety of options, one key metric that stands out among all others is the total real yield.

The total real yield is defined as the nominal yield of a given investment vehicle minus the rate of inflation. Basically, it’s the return on an investment once inflation has been factored in.

It’s difficult to overstate how important the real yield actually is; in fact, it’s fundamental to almost any type of investing strategy. There’s little point in having a high yielding stock, say, if the inflation rate is so high that its deleterious effects cancel out all of its actual profit.

In reality, real yields normally only concern investors who are holding bond-like securities, such as the US Treasury Inflation-Protected Security (TIPS).

Indeed, the 10-year US TIPS real yield is tied to the US Consumer Prices Index, meaning that the bond, in theory, is meant to protect its holders should the spending power of their money decline. Securities like these are not generally high yielding, but are intended to outperform inflation rates at the very least.

However, the US TIPS has been negative for some years now, a consequence of policy action by various central banking authorities. This negative yield implies that investors will actually lose money if they hold the bond, and the result of this has some knock-on effects for market behavior.

For instance, if a supposedly “safe” investment like a government-backed bond returns a negative yield, then investors are more likely to turn to riskier investment options that they feel will reward them better over the long-term.

A Worrying Development

This story doesn’t end with only negative bond yields, however. A recent phenomenon has just occurred: the stock market itself is now seeing negative total real yields across earnings and dividends. It isn’t entirely unprecedented; the last time it happened was in 1946 – but for today’s crop of investors and analysts it’s certainly a novelty.

What does this mean then, if both the bond market and the stock market are showing signs of negative yields?

Well, the most important thing to note is that although earnings and dividends are not yielding positive returns, the S&P 500 Index isn’t losing market capitalization either.

Share prices continue to rise faster than inflation, and so growth investors aren’t that hard hit. In fact, when negative earnings and dividend yields reverse from negative to positive, it appears that stock prices begin to rally. 

What Does It Mean For Investors When Real Yield Is Negative?

There are some strange effects arising out of negative investment yields that also happen at the same time that stock market valuations are going up. Typically, if real yields are low, that suggests that either inflation is high, or that earnings and dividends are depressed – or both.

Currently, inflation in the US is growing, with June marking a 13-year high inflation rate of 5.4%. At the moment, the S&P 500 earnings yield stands at 3.23%, while its dividend yield is at 1.32%. You can see that the sum of these two yields – 4.55% – is below the inflation rate, showing how these two metrics are together being outpaced by rapidly speeding up inflation figures.

This situation is disastrous for both income and growth investors alike.

First, dividend payouts are one of the main cash streams that income investors rely on for a big part of their shareholding remuneration. But if real dividend yields are low – as they are right now at just 1.32% – then the return on that investment is simply wiped out by rising inflation rates.

Second, if earnings yields are low – which again, they are, at 3.23% – then the money in the form of business profits that companies use to initiate and fund share buy-back schemes is worth less due to inflation too. This makes buy-backs less likely to happen, which means that the share price boost from those buy-backs is lost, and growth investors are left holding stocks which will be worth less over the long-term.

So, what are the strange effects of these outcomes?

Principally, investors begin to seek more novel and exotic investment opportunities, since the traditional forms of investing aren’t doing what they’re supposed to do. Safe, but reliable, bond options are no longer either of those things, and the higher returns promised of the stock market stop producing the results investors need.

This, in fact, could account for the rise of relatively new types of speculation, such as the rush to buy crypto-currency, or the explosion in Forex trading among retail investors. It might even explain why institutional investors like Michael J. Saylor at MicroStrategy, or Cathie Wood and her ARK Invest portfolios, are seeking exposure to technologies in the blockchain space.

S&P 500 Negative Total Real Yield: Wrap-up

Negative yielding bonds and stock returns are rarely ever a good thing for investors. It usually hints at some underlying inefficiency in the market, but can also be a harbinger of a positive reversal in the near future.

For investors that find themselves on the wrong side of a bad yield, temporarily moving their focus onto atypical investments ideas i.e. fine art, wine etc. might offer some upsides until things turn back to normal.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.