Knowing the difference and the interaction between certain types of yield in financial markets will better equip investors with the awareness of when a bull or bear run on share markets is likely to happen, according to an investment analyst.
“The relationship between earnings yield and interest yield is one of the most important relationships in understanding financial markets,” VectorVest Australia managing director Asia Pacific Rob Markham told attendees at the recent Australian Shareholders Association Conference 2017 held in Melbourne.
“This is where the battle is being fought every day in financial markets,” he said.
Markham described earnings yield as earnings per share divided by the stock price expressed as a percentage.
With this in mind, he said, typically when earnings yield is higher than interest yield this indicates investors are fearful.
“In other words stock prices are low and bond prices are high and investors are taking their money out of stocks and putting it into bonds,” Markham explained.
“Currently here in Australia the earnings yield of the All Ordinaries Index is about 5 per cent, the interest yield on 10-year government bonds is about 2.5 per cent, triple A rated corporate bonds are around about 3.5 per cent, and the 90 day T-bill rate is around the 2 per cent mark.
“So earnings yield is greater than interest yield showing that there is some fear in the market.”
Markham pointed out the interaction between these two yields in recent times has been an accurate indicator of investor behaviour. He cited the period incorporating the 1980s and ‘90s prior to the global financial crisis (GFC) as a good example.
“During this time interest yield rose above the earnings yield and we had the bull run,” he said.
“Then during the GFC 2007/08 to the beginning of 2009 we saw fear in the market.”
In relation to the current state of Australian financial markets Markham revealed dividend yield, closely correlated to earnings yield, rose above interest yield.
“It does give us some indication that we are moving possibly into a hiatus as to whether it is risk on, (a period with increased allocation to shares) or risk off (where bonds will be more popular),” he concluded.