The speculative premise here, as well as I can discern, seems to be that low short-term interest rates are “good” for the financial markets and that, in the absence of a material increase in interest rates by the Federal Reserve, speculative assets such as stocks, corporate credit and even junk debt will be naturally driven higher because they represent a desirable alternative to low-yielding, default-free liquidity.
According to this premise, the fact alone that the Standard & Poor's 500 dividend yield of 2.17% is higher than the 10-year Treasury yield of 1.71% should make it clear to anyone that stocks are still a competitive investment. The expectation of future dividend growth only makes a compelling case more so.
I think that’s the logic.
The one little problem is that it wholly ignores precisely the thing that makes all of those speculative assets different from low-yielding, default-free liquidity: risk. The argument follows only to the extent that one can rule out capital losses. See, the speculative premise outlined above comes with some verifiable implications. For example, we should expect that periods of low interest rates should be associated, generally, with shallower overall market losses across history. Unfortunately, just the reverse is true. The chart below shows data from 1926 to the present, plotting the loss in the Dow Jones Industrial Average from its highest level of the preceding two-year period, against the average Treasury bill yield over that period. Notably, the deepest market losses (those that followed the 1929, 1937, 2000 and 2007 market peaks) were actually associated with relatively low short-term yields.
But maybe we’re asking the wrong question. Maybe what matters isn’t the level of the yield, but the change. Surely, we should observe the shallowest market losses in periods where short-term interest rates were stable or falling. Again, unfortunately, the reverse is actually true. The deepest market losses in history were associated with no rise in short-term interest rates at all. The chart below plots the loss in the Dow Jones Industrial Average from its highest point over the preceding two-year period, versus the change in Treasury bill yields from their lowest point over the preceding two-year period.
