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Bond and Cash Yields in 2023
It’s been an interesting year to be an investor and I think it’s likely to get even more interesting as cash yields and bond yields are quickly approaching 5%.
Why does that matter? Well it matters because investors don’t look at asset prices in a bubble and while stocks have dropped, earnings yields are still south of 5% against a historical mean of ~6% and rising cash yields will pressure that.
As cash flowed into the economy at a rapid clip in the last few years, those earnings yields(due to rising P/Es) fell and fell, mirroring what was going on with cash and bonds. After all, if cash yields are basically 0% and bond yields not much higher, why hold anything in cash? That certainly explained the rise of alternative investments that have now crashed in value.
Now that cash yields and bond yields are rising, stocks are falling in tandem but that doesn’t mean they’re done especially if the economy falters a bit. After all, like I said, a 4.6% earnings yield on the S&P is certainly better than what we had in the past but now that cash yields are normalizing and sitting closer to historical norms, is it cheap enough? It’s certainly not as bad as the 2000 market crash which had 6% cash yields being compared against 2.5% earnings yields but it still leaves room to question pricing.
Now, if you’re worried about the economy or concerned about valuations, there’s somewhere else you can put your money. While I don’t time the market, I do have an investment plan that calls for a 10% max in cash and I’ll let you guess where my cash position is right now. Now stock prices are certainly more appealing now than they were a year ago but are they appealing enough to go all-in? I don’t think so.
Of course it’s impossible to predict where stock prices go in the short-term but in the long term, buying today should still be fine. One just has to temper their long-term return expectations given market dynamics. Naturally, a 5% risk-free rate may sound great but, at least as today, it’s mostly a short-term yield as investors expect yields to fall in the near future. That means they could change anytime(and go lower) with no potential for growth from today if you buy bonds today whereas earnings yield WILL eventually continue to grow.
Still, it’s no surprise that stocks are all over the place leading to short term pain. I’ve seen a lot of people hoping for a fed pivot but that doesn’t seem to be the right move given inflation still being a pressing issue. On top of that, that seems like a false hope for people who are down quite a bit since a fed pivot likely means the economy is in the dumps and earnings are falling which might be the worst thing one can hope for leading to a double whammy of falling prices due to shrinking P/Es AND falling earnings.
After all, most of the price appreciation in the past few years wasn’t due to amazing growth but simply due to expanding P/Es driven by low yields on everything else.
In fact, what worries me now isn’t the growth stocks that have already fallen 60% but it’s the safe stocks that are growing at 2% a year but still getting a P/E of 25 because they’ve paid out dividends during recessions and are seen as safe. That’s a problem because there’s really no such thing as a safe stock during a recession.
Just look at the performance of dividend ETFs during the 2008 recession, even something like VYM dropped 50% and cut dividends by 20%. I’ve certainly seen more people look into dividend investing as a safe haven after what happened in the growth sector and I’m not sure that’s a good strategy right now because those stocks have been bid up and sit pretty close to their 52wk highs. How can something be worth what it was worth back then when alternatives have gotten so much more attractive and earnings growth has been anemic.
If your stock is earning $2 today and is given a P/E of 20 by the market because it’s seen as a safe stock, that’s a price of $40. If earnings suddenly drop to $1.20 in a recession then that P/E certainly won’t remain 20 but will drop to 15 or even 10. Suddenly, your safe stock is trading at $12. That’s how a safe stock can be a poor investment. Now that doesn’t mean it will never return to $40 and grow from there but it may take some time to get there as it did for things like VYM. We’ve already seen a few dividend cuts from dividend aristocrats and maybe we’ll see more.
I certainly don’t hope that happens but I also don’t see today’s values on some of these stocks given as a block buster deal. At the end of the day, I try not to time the market knowing it’s a fool’s game in the long run but I don’t mind holding cash in situations like this one where cash yields are actually pretty decent.
After all, an investor right now can get a better yield from cash or bonds than most dividend payers. Should that make those dividend stocks fall in value? I think so. Has it? Not really. And yes those dividend stocks will grow their dividends but something like VYM pays a 3% yield and has grown at about 6% annually. It’ll take a while for that to 5% yield on cost if you buy today.
Everyone will say VYM is still a better deal because earnings and price will grow and that’s possibly true but one has to take into account the risk that goes into that choice. A 4.5%-5% risk-free rate means one should be getting 7%+ or more for taking a risk and while certain stocks can deliver that, it’s still not overly common.
Are there some good values in the market today? Yes, but if I can’t find many, cash isn’t too bad right now either(even if inflation is still a problem). And I’m not saying stocks should fall another 50% to be healthy but another 10-20% is reasonable in my mind before I start getting really interested.
Now, let’s take a look at my dividends for the month. We’ve seen pretty significant growth lately as yields on non-stock assets have soared so that’s been a boon to the latter part of 2022 and should be seen in the early parts of 2023 as well.
Last January’s dividends came in at $268.06 so let’s see where we are today.
January came in at $667.38, a ridiculous 149% boost over last year.
What drove that? Well, a full year of investments will certainly help but I also hold a bevy of fixed income investments(very short term because of where rates were in the past) that also saw their yields almost quadruple within the year. I might start shifting some of those to more longer term investments as interest rates start to stabilize to lock in those higher yields for a longer period of time. Cash yields also helped as my cash pile grew and those yields increased. I’m still utilizing that cash as opportunities arise but I don’t mind sitting on that longer in this type of environment.
Steve, my dividend employee, gets off to a good start in 2023 with a $4.00/hr. salary. That’s not anything amazing but last year January was my smallest month and while I doubt that is the case this year with this type of growth, it’s a very good sign for things to come.
Re-investing dividends is key in growing future payments as well due to the compounding effect of that re-investment and January’s dividends re-invested at my annual yield will bring future annual income up by $22.69. It’s not a huge amount but certainly helps growth going forward.
That’s a good thing especially as January is one of my smaller months as shown by the graph below.
You can see the quarter ending months are by far the biggest drivers of my dividend growth but these smaller months are getting up there too. That’s a nice thing to see and it’ll be awesome to see a non quarter ending month hit that $1,000 mark sometime in the next few years. Naturally, if a recession were to hit, that might not happen anytime soon but if it doesn’t then this type of growth might be able to continue as I invest and re-invest more money.
At the end of the day, no one can know where the stock market goes. If I had to guess, I’d lean towards poor returns in the short term but given than my guesses often turn out to be wrong, I’ll always stay invested because it’s far more harmful to predict and be wrong than just stay in and ride the wave as long as you have a long term mindset. If you’re out of the market and miss a few good days, that could have a huge impact on your overall returns. That’s why time in the market ends up winning because you can’t perfectly predict the bad days and capture the good days and they often happen close to each other.
So while I have some cash, I still always believe that the market is the best place for most of my money as it has been historically. I do enjoy my strategy as it allows me to have some side cash to invest in and take advantage of any downturns but protects me from missing out on any upticks and hell, even in a bull market, good deals can always be found so having cash on the side isn’t all that bad especially when money market funds start to approach 5%.
Thanks for reading and see you soon for another update.