IN 2005 THEN–Federal Reserve chairman Alan Greenspan mused about the “conundrum” of low long-term U.S. Treasury yields in the face of a rising federal funds rate. Today many analysts are again baffled by low bond yields, this time citing two different conundrums.
Bond yields could not possibly remain so low relative to equity earnings yields and dividend yields, people say. Nor could recent bond yields possibly make sense in light of current inflation levels, they say. But neither of these assertions holds water when examined with proper perspective. On the contrary, Treasury yields are likely to remain low for years, although brief rises are certainly possible. Moreover, new lows in Treasury yields probably still lie ahead.
Consider the first conundrum: the current relationship of Treasury yields to equity and dividend yields. In both the third and fourth quarters of 2011, the earnings yield on the Standard & Poor’s 500 Index was more than 2.5 times the composite long-term government bond yield, by far the biggest multiple in the past 50 years. And in the fourth quarter, the dividend yield on the S&P 500 (2.13 percent) was only barely below the composite long-term government bond yield (2.7 percent) — the narrowest gap in decades. These facts are cited as reasons that bonds have been overpriced. ....