If the sustainable state for the next several years includes an average 4-5% nominal 10-year Treasury yield and a slightly enhanced equity risk premium (say around 4-5%), but earnings growth underperforms nominal GDP growth (i.e., sub-4%), it must follow that dividends yields could rise to 4-5% and that yield has finally earned its place in the total return profile for US equities.

For a very long time the S&P 500 offered a yield of only 2% against a risk premium of 3.5%. A rise in the dividend yield can be interpreted in two ways. Either the risk premium has risen permanently (maybe to 4-5%) and the dividend yield has to rise accordingly. Or alternatively, the long-term earnings growth expectation has shifted down, implying expectations of low GDP growth and even weaker earnings growth, so that the rise in the dividend yield is necessary to compensate within the total return profile.

The acceptance of a low payout ratio and low dividend yield in the second half of the 1990s reflected a significant rise in long-term earnings growth expectations from 12% to an absurd 18%. Usually such a rise in growth expectations is accompanied by a rise in risk premium (higher growth is generally associated with higher risk). And a rise in risk premium should have caused a commensurate decline in the P/E. But instead, during the bubble period the P/E expanded despite the lower dividend yield and higher risk premium associated with higher growth expectations. As Exhibit 7 shows, the decline in the dividend yield over this period would have traditionally been associated with a decline in the P/E of nearly 50%. Instead, we saw an almost tripling of the multiple.

We may well be entering a phase that is the exact opposite of the second half of the 1990s, consisting of persistently falling long-term earnings growth expectations, no scope for P/E multiples to expand, and demand for higher payout ratios and rising dividend yields as the dominant feature in total returns.

Eoin Treacy's view Companies with solid, reliable cash-flows that dominate their niches on the global stage outperformed the wider market from late 2008 until relatively recently. They are now receiving increased attention because the export sector is outperforming, since it is leveraged to growth in the global middle class, focused in Asia. Their reliable cash-flow also allows them to pay highly competitive dividends. (Also see Comment of the Day on the 18th and July 21st 2009; the second of which is available to pre-subscribers in the archive following the customary 4-month waiting period.)


Having highlighted Belgacom and Vodafone on the 18th, the commonality in the communications sector extends to AT&T which yields 6.23%. The share remains in the developing 22-month base formation and is currently rallying from the lower side. A sustained move above $30 would complete the support building phase and indicate demand has regained dominance.

Heinz (3.87%) remains a relative performer and rallied this week to break the 5-month progression of lower rally highs. A sustained move back below the 200-day MA would now be required to question potential for some additional upside.

CMS Energy Corp (4.93%), although concentrated in Michigan rather than leveraged to the global market, is outperforming the Dow Jones Utilities Index (4.47%) and has a higher yield. The share broke out of the most recent range three weeks ago and while now a little overbought, a sustained move back below $15 would be required to question the consistency of the medium-term uptrend.

Johnson & Johnson (3.68%) pulled back sharply in May and has been ranging mostly below $60 since. While the competitive yield might help to cushion the share, a sustained move above $60 is needed to indicate demand has returned to dominance.

Conagra (also 3.68%) has plotted a progression of lower rally highs since late March and dropped below the 200-day MA three weeks ago. While it is somewhat overextended in the short-term, a sustained move above $24 is now required to question potential for some additional downside.