Implications of a 1% Yield for Bonds and Stocks

IBM just sold 3-year bonds at a 1% yield, providing historically-low returns to investors.  This level of yield on corporate bonds has substantial implications for long-term investors.  First and foremost, yields this anemic make it hard to generate reasonable levels of income from a portfolio.  Granted, this level of yield is about twice what you can get with a short-term government bond index fund which invests in bonds with average maturities of 1-3 years, but this is hardly an attractive situation.

There is clearly an interesting process at work.  Investors are clearly voting for bonds over stocks.  IBM’s stock has a projected yield of 1.97% and a trailing yield of 2%.  In some ways, we can see the current situation as a progression from the 2008 crossover in which the yield on the S&P500 exceeded the yield on 10-year government bonds for the first time in fifty years.

In the event of corporate default, bond holders will fare better than equity holders, and bonds are typically considerably less risky than stocks.  So, it makes sense that stockholders should expect to receive higher average returns than bondholders–though that has not been the case in recent years.  One way to interpret the very low yields on corporate bonds is simply performance chasing: investors want to put their money into the assets that have done well recently.

Another way to interpret the very low yields on corporate bonds such as IBM’s recent offering is simply that investors have become far more risk averse in recent years, due to the big losses in equity markets.  Another argument is that investors are heavily discounting the potential for future earnings growth that would be needed to drive stock price appreciation that would make stocks attractive.

Regardless of the cause, there is no question that the vast majority of investors cannot possible live on 1% yields, much less grow their portfolios.

This entry was posted in Income Investing and tagged , , , , on by .

About Geoff Considine

After earning his Ph.D. in Atmospheric Science, Geoff worked for NASA for 3 years, leaving to become a quantitative analyst developing trading and portfolio management solutions for an energy trading firm. In 2000, Geoff became a consultant focusing on quantitative methods in portfolio management. Geoff founded Quantext in March 2002. Geoff has published commentary and analysis in a range of publications. Quantext is a strategic adviser to FOLIOfn,Inc. (www.foliofn.com (http://www.foliofn.com)). Neither Quantext nor Geoff Considine is an investment advisor.

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