August 10, 2011 will go down in financial history. On that day, the S&P 500's dividend yield at the close was 2.17%, which was above the yield on 10-year Treasuries of 2.14%. This was only the fourth such occurrence since 1958, with 1962 and 2008 providing the only other modern-day examples. More interesting to note is what it could potentially signal. Although the sample size is quite small, based on the three previous occurrences when the S&P dividend yield was above that of Treasures, the average return on the S&P 500 12 months later was 18.5%. Even 2008, in the midst of a financial market meltdown and with equity dividend yields being quickly reduced, produced a positive return of 23.5%.
The obvious question now is will history repeat itself?
To be clear, there could be more downside in the market because no one can time a bottom very well, especially when investors are panicking and irrational behavior prevails in the short term. But a decline in confidence is very different from a decline in financial worthiness.
Fundamentals do matter, and they are not as bad as the recent market activity would indicate. In fact, if the fundamentals worsen, it appears this scenario has been priced in. Even if we do enter a double-dip recession, most of the damage to the market probably has been done already because the average market decline from peak to trough is about 25%.
No one knows for sure if history will be repeated, but the fundamentals are much more favorable now than during the last S&P dividend yield occurrence in 2008.
