Change is hard, but it’s part of life. A big change some investors may have noticed over the past few weeks is the move up in Treasury yields. The 10-year Treasury yield, as of 2-1-18, has gone up to levels we haven’t seen since April 2014. While that’s a rather large move up, in a historical context, yields are still very low.
For Treasury yields, in nominal terms (i.e., not adjusting for inflation), yields have been higher about 75% of the time, over the span of roughly 100 years. In that same time period, the dividend yield on the S&P 500 Index has been higher 90% of the time. Corporate bond yields, as measured by the Moody’s BAA Corporate Index, have been higher 84% of the time.
As you’ll see in the following chart, the yields most people grew up with are not the yields most people will grow old with, especially in nominal terms. To get a better perspective on what inflation-adjusted yields looked like in the past, and what they look like today, I adjusted historical yields for inflation by using the Consumer Price Index’s realized annualized 10-year inflation gauge.
After adjusting for inflation, yields do not look rich, but that doesn’t mean we’re in a yield-poor environment. Looking back again over nearly 100 years, the real 10-year Treasury yield has been higher 65% of the time, the S&P 500 Index real dividend yield has been higher 66% of the time, and the Moody’s BAA Corporate Index real yield has been higher 62% of the time. A 2% inflation rate–which is what I used in our research to adjust current yields for inflation–is in the bottom 30% of all observation going back to 1919.
Because yields are still below middling, I like expanding the opportunity set for seeking income to different geographies and different asset categories.
As my recent blog post “Income under the microscope” pointed out, the income component of a portfolio’s returns can be more stable than the price component, in terms of standard deviation. The income component can also be more significant than the price component, in terms of total return contribution. From my perspective on the Multi-Asset Solutions Team, looking for significant income that is stable is an essential step for building portfolios with sustainable income in a risk-managed way, in the pursuit of total return.
In line with this significance-with-stability approach, the below chart shows the current yield versus the historical volatility of the yield for a variety of asset categories and geographies. Volatility is gauged by the standard deviation of monthly yields from January 2012 through January 2018, which is the longest common time frame for all indexes we’ve placed under the microscope.
What you’ll notice is, there’s a trade-off between seeking yield and the reliability of yield.
The takeaway for investors: Each of these multi-asset categories can have a place in a diversified portfolio, depending on income potential and risk characteristics, while taking into account fundamental factors like investors’ goals and time horizons.
Today’s environment is not like the environment many people grew accustomed to. Investing for the future requires casting a broader net than it did in the past. The yields we knew aren’t the yields we have; nor are they likely going to be the yields we have in the future.
In an upcoming blog post, I will hone in on the geography of income opportunities, looking at income opportunities in the equity and fixed income categories by countries and by sectors.
Standard deviation of return measures the average deviations of a return series from its mean and is often used as a measure of risk.
Dr. Brian Jacobsen, CFA, CFP, is a Senior Investment Strategist with the Wells Fargo Asset Management Multi-Asset Solutions.