Since the beginning of the year, longer-term interest rates in the U.S. have risen considerably—mostly driven by the expectation that the Federal Reserve (Fed) would begin tapering its quantitative easing (QE) program. At its December meeting, the Fed did indeed announce it would begin scaling back purchases of both mortgage-backed securities and U.S. Treasury bonds by $5 billion a month and now would be on track to end its asset purchase program by the end of 2014—assuming no drop-off in economic performance in the coming months.
Although more companies have begun paying dividends, the percentage of equities with a higher dividend yield than the 10-Year U.S. Treasury yield has declined. The recent rise in Treasury yields has impacted various income-oriented investment strategies, but not all strategies are the same. In the chart below, I look at how the relationship between the 10-Year Treasury and dividend-paying equities has changed over the past year, up until the most recent Fed announcement.
Relationship between Equity and Bond Yields
• Rates Have Risen Rapidly – Through December 18, 2013, the 10-Year Treasury yield has increased from 1.76% to 2.89%—a change of 113 basis points. To put this in context, rates still remain well below their monthly average of around 6.0% over the last 30 years. But as interest rates increase, they provide more competition for dividend-paying equities, especially higher-yielding equities.
• Dividend Yield Edge of Equities over Bonds Has Decreased – Within the S&P 500 Index, the weight of dividend-paying equities with an indicated divided yield above that of the 10-Year Treasury has decreased dramatically, from 67% to 24%. WisdomTree Indexes have also seen a decline in weight, but the percentage with higher dividend yields is still higher due to the Index methodology that focuses on dividends. In particular, the annual rebalance back to the Dividend Stream® puts an emphasis on stocks with higher dividend yields, as weights are adjusted such that more weight is allocated to firms that grow their dividends faster relative to their prices.