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Thursday, 3 January 2013

10-year Average Earnings- and Dividend Yields, S&P 500 (as of 2 Jan-13)

Earnings - and dividend yields as of 2 January 2013

Based on the closing price of the S&P 500 index of 1,462,42 on 2 January 2013 and data from Professor Robert Shiller's home page, the current 10-year earnings- and dividend yields for the S&P 500 index are as follows (please refer to the June 2012 analysis for background information):

The earnings yield and the dividend yield declined 3.14% (0.15% points) and 2.81% (0.05% points) respectively from that reported on 27 November 2012. This was mainly caused by the S&P 500 index increasing 3.99% since the previous report. The current earnings yield is 22.98% lower than the historical average since 1978 while the dividend yield is 32.96% lower. The two combined therefore indicate the current market valuation of the S&P 500 is significantly higher than average.

The spread (the difference between earnings yield and interest rate) decreased since the previous report mainly as a result of the price increase of the S&P 500 index, decreasing from 2.99% as of 26 November 2012 to 2.76% as of 2 January 2013.* The spread remains considerable higher than the average negative spread of 0.99% since 1978. One (of many) likely reason for this, as previously reported, is that bond yields are artificially low due to the support from the Fed. In a historical perspective, the spread indicates the current market valuation of the S&P 500 index is substantially lower than average.

On balance, the S&P 500 index today is substantially more expensive than average based on earnings- and dividend yields. Furthermore, if the earnings yields for the period 1998 to 2000 (3 years), a period when the market valuation of the S&P 500 index was very high, are removed from the data set, the current earnings yield of 4.54% is 27.03% lower than the adjusted average earnings yield of 6.23%. If the same adjustment is done for the dividend yield, the current dividend yield of 1.77% is 36.35% lower than the adjusted historical average of 2.78%. Purely based on average earnings- and dividend yields, adjusted and unadjusted, the S&P 500 index at its current level is substantially more expensive than average. However, based on the current high spread between the earnings yield and interest rates, driven by the latter, the S&P 500 index is substantially cheaper than average.

In conclusion, the current market valuation of the S&P 500 is high compared to historical averages going back to 1978, but with the current low level of interest rates this is perhaps understandable. And there have also been many periods when the index has achieved a higher market valuation than is the case today. But there have certainly been, and will be, better opportunities for the patient long term investor to go long the S&P 500 index. This is more so the case today compared to the previous report following the 3.99% increase in the S&P 500 since then. The current low level of interest rates is a significant driver of the current market valuation. But with a growing federal debt burden, artificially low interest rates driven by Fed policy and significant increases in money supply, there is a limit to how long interest rates can remain this low as eventually the Fed might have to reduce its purchase programs to limit consumer price inflation running out of control. And when they start to increase, the spread between the earnings yield and interest rates will be reduced, and the index will look even less attractive as an investment.

* As the monthly interest rate (GS10) is yet to be reported, the daily interest rate (DGS10) reported as of 31 December 2012 has been used.