No. of Recommendations: 32
I was looking at a graph of S&P 500 dividend yields recently.
Obviously earnings go up and down a lot, so they need a lot of smoothing to make sense of them, and it gets to the point that the smoothing involves too many decisions.
Dividends go up and down as well, though not as much.
(sales are even less cyclical, but ignore that for the moment).
The thing that struck me about the dividend
yield graph is that it has been so flat in recent years, at least compared to earnings or dividends themselves.
Maybe managers pick a dividend yield, then shareholders have been (implicitly) bidding prices to a level that keeps the yield on the current price in a narrow-ish range. When it gets outside that "normal" range, it seems that prices adjust back towards it. In the last 10 years, the average yield has been 1.87%, so that's the general range the market seems to think is normal. It was amazingly flat at around 2.0% from around 2009-Q3 till the pandemic (prices fell, so yields spiked). The credit crunch caused another spike, but before that it was very steady around 1.8-1.9% from about 2002-Q3 to end 2007, not so different.
The result is that a number as amazingly simple as the current reported S&P 500 dividend yield is a not-bad predictor of forward market returns. Or at least it has been in the last 1-3 decades, anyway. The forward time horizon I looked at was 1.5 years: the average of the annualized rates of real total return for all hold periods of 1-2 years. So, for example, the likely rate of return you'd get now selling at a random date sometime between Feb 2024 and Feb 2025...the middle of which is 18 months from now.
Here is a graph of the observed return results, starting from three different dates in the past.
http://stonewellfunds.com/DivYieldAndForwardReturn...X axis is starting reported dividend yield, Y axis is average of annualized 18-month forward real total returns starting from that initial dividend yield.
I did a fit through each of those lines, and averaged the three fits to create this graph, suitable for pinning to your wall.
http://stonewellfunds.com/DivYieldAndForwardReturn...Given the dividend yield on a given day what is the likely 18-month forward real total return for SPY?
The red point on the Y axis is located at today's dividend yield, though the chart could be used any time.
Using the latest figure (1.45% at the moment from Pinnacle, who uses Dow Jones News I believe), the forecast for the next ~1.5 years is an annualized rate of real total return of -3.28%/year.
It appears that this very simple model thinks the current dividend yield is low enough that there's likely a bear market coming. We'll see what next year has to offer.
As an aside:
Since dividends do go up and down somewhat with the business cycle, I figured that a smoothing of the real dividends would let me create a cyclically adjusted dividend yield (it does) which would make a better predictor (it doesn't). It seems the market reacts to the *current* level of dividends, not the "supportable" level of dividends. The side effect is that this particular model is dead easy: just look up the current dividend yield of the S&P 500 and look it up on the second chart above. (trailing, not forward).
As always, the prediction will be wrong, but the notion is this: given no other information, it's a 50/50 chance whether the market return will be higher or lower than the number you get.
Jim
