One of Wall Street’s most bullish stock-market strategists has given clients another reason to buy more stocks in 2016.
For Fundstrat’s Tom Lee, the higher yield investors can get from stocks instead of bonds is another reason to own equities, besides the built-in upside potential for stocks he projects.
And so, in 2016, stocks are the “new bonds”, according to Lee in a note on Friday. His 2015 year-end target for the S&P 500 is 2,325.
He wrote, “Equity valuations are also finding support from dividends. The drop in equity prices has pushed dividend yields to over 2.2%, and given the current 10Y yield of 2.23%, means equities are now yielding essentially the same as 10Y bonds. In fact, this yield is even greater when taking into account the differences in taxation.“
The chart below illustrates that the gap between dividend yields and the treasury 10-year yield has been widening.
Lee used Walmart as an example of a company whose stock-dividend yield is paying more than its own bond yield.
As an AA-rated issuer, the company is paying a yield of 2.7% on the long-term debt, lower than the stock’s yield of 3.2%.
Lee wrote that this means “the equity pays a yield 49bp higher than the AA-rated bonds — does this make any sense?”
Lee noted that there are 130 companies on the S&P 500 whose dividend yield is higher than their long-term bond yields. Most of them are in the financials, utilities, energy and industrials sectors, and have have credit that’s BBB- to A-rated.
Besides Walmart, others include Coca-Cola, Target, and Pfizer.
And if it happens that stocks get even cheaper, Lee says companies would salvage this by buying back their own shares.
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