Stronger countries like the US and Germany have seen their treasury yields touch record low, while the troubled economies like Italy and Spain’s yields have touched new highs. This divergent reaction to global events signifies that money is moving from weaker economies to stronger ones.
Tsutomu Komiya who oversees the $111 billion investments of Daiwa Asset Management Co. has been quoted in Bloomberg as saying, “Yields are telling us that the world is headed for a recession and the euro may break up, it’s going to be a long battle to stabilise the world economy.”
The US 10-year bond yields have touched an all-time low of 1.608 per cent on May 30, 2012, lower than the previous low of 1.672 per cent touched in February 1946. German two-year yields are near zero per cent while their 10-year yields have touched a record low of 1.259 per cent.
Analysts in the US are expecting the government to go in for the third round of quantitative easing (QE3) even as economic data from the country show that the economy is not able to hold on to the growth witnessed in the first quarter.
The last time quantitative easing (QE2) was launched, there was a sharp rally in various asset classes across the world. This time around equity market, at least in the US, appear ripe for a rally if QE3 is launched. Even if it does not, there is reason to believe that there is limited downside for the S&P 500.
This is because around 56 per cent of the stocks in the S&P 500 index are trading at dividend yields higher than US bond yields. Investment chases returns. With US equities offering higher dividend yields plus the scope of an upside in case of a rally, money is likely to move or stay in stocks. With treasury yields being lower than equity yields, the equity markets would appear attractive.
While there might be a reason to buy the US equities, the same reasoning cannot be applied to the Indian markets as their treasury yields are at 8.5 per cent while dividend yields of Nifty stocks are around 2 per cent.