Yield Versus Yield

Lately there have been a lot of commentaries making the argument that instead of buying fixed income for yield it makes more sense to buy equities for yield as bond substitutes. Whitney Tilson has used the example of Johnson & Johnson (JNJ), which is a client holding, in pointing out that the company recently issued ten year paper at 2.95% with the common yielding what is now 3.49%. Tilson says it makes much more sense to buy the common for the potential price appreciation and the reasonable likelihood that the company will continue to increase the dividend which the company has done every year since 1752 (slight exaggeration).

Carrying out the thought a little further fixed income yields are at all time lows, or close to it while the S&P 500 is 27% below its 2007 peak and 25% below its March 2000 peak. It would be tough to argue that stocks aren't relatively cheaper than bonds--I've been writing for ages that I think bonds are way overpriced and so have been keeping maturities very short and obviously bonds, or anything for that matter can stay very expensive for a long time and stocks can stay "cheap" for a long time.

So the market is at a point where there are plenty of well run, fundamentally sound companies with high dividend yields such that an investor spending a decent amount of time looking for names could construct a portfolio whose yield was higher than, or at least competitive with a high quality bond portfolio.

Maxim Integrated Products (MXIM) 5.0% yield
Eli Lilly (LLY) 5.50% yield (clients own LLY debt)
AT&T (T) 6.0% yield
Eni (E)4.5% yield
BP Prudhoe Bay (BPT) 8.4% yield
Komercni Banka (KMBNY) 3.0% yield Czech bank mentioned a few weeks ago
Altria (MO) 6.3% yield (clients own this one)

The group covers a lot of ground and depending on how someone might blend them together--note not all of the big SPX sectors are included--the yield could be 5% overall without whoring out to a bunch of companies with lousy stats, IMO, but you can draw your own conclusions.

From the top down I don't think any of these stocks are insanely risky relative to what they are proxies for; meaning that if the Italian market dropped 15% I don't think Eni would drop 40%. Not that this can be overly relied on going forward but the betas of these names, interestingly Komernci Banka has a beta of 0.43, are reasonably tame, the coverage of the dividends is decent and as I said the foundations are pretty solid as equities go of course given the disclosures above I don't really have to worry about being correct.

The above mix actually could be a pretty good start to building an equity portfolio for someone but the key is equity portfolio. MXIM dropped about 60% from peak to trough but that was right in line with the iShares Semiconductor ETF (IGW). LLY did a fair bit worse than the Health Care Sector SPDR (XLV) on the way down, dropping as much as 50%, and at the start the market's snap back but has outperformed by a little in the last year. T has done a little better than the iShares Telecom ETF (IYZ) fairly consistently but it did drop 40% at its trough. Eni dropped almost 60% but that was much better than the iShares Italy (EWI). BPT did much better than the Energy Sector SPDR (XLE) which may not be an apples to apples but from its peak about six months after the SPX' peak BPT dropped 50%. Komercni Banka dropped about 60% from it's peak which sounds bad but the Financial Sector SPDR (XLF) dropped 80% at its worst. Finally MO did a little worse than the Staples Sector SPDR (XLP) dropping slightly more than 30%.

The point of that last tedious paragraph is that there is nothing bond-like about those results. Relative to equities, the results above are not bad and you may agree with that or disagree but again there is nothing bond-like about them. After two 50% declines in ten years another one is unlikely (not impossible of course) but even in a normal bear market, like maybe a 30% decline with no reasonable fear of financial Armageddon, the above stocks would still go down plenty even if it were to be less than the market. Down 25% in a down 30% world is a fine equity market result, or not, but again it is not bond-like. For a little bit of context I am talking about individual bonds not bond funds some of which malfunctioned during the crisis and obviously I am assuming, perhaps unfairly, someone avoided financial sector bonds.

As you read more commentaries along these lines it is crucial to understand there is a big difference between buying stocks that probably won't go down as much as the market and buying bonds. A portfolio that only owns stocks like the above should be expected to go down a lot during a bear market even if they were to go down less, a lack of recognition of this ahead of time would likely cause a lot of anguish.

The picture is of the Bay Bridge taken from Pier 24 in San Francisco by AW, a long time reader of this blog.