A confluence of factors helped U.S. equities rebound more than 12% from their October low, pushing valuations to their highest level since 2009. Besides extraordinary foreign central bank monetary stimulus (with the latest shot of adrenaline coming from China) and a fresh wave of mergers and acquisitions, I discuss in my new weekly commentary how low and stable U.S. interest rates are another significant driver of the rally. Income-oriented stocks have appreciated considerably and now appear overvalued as investors continue their reach for income in this low yield environment.
Reasons why U.S. rates are so low
Despite the two best back-to-back quarters of economic growth since 2003, U.S. long-term yields refuse to budge. Declining inflation expectations are one reason yields are remaining so low, and another reason is yields in other developed countries are even lower. With German and Japanese bond yields well below 1%, a 2.35% yield on a 10-year U.S. Treasury seems attractive in comparison. This entices investors to buy Treasuries, supporting their prices and keeping yields low.
Yield Seekers Pushing Up Prices for REITs, Defensive Stocks
Thus, investors in need of income continue to look for alternatives. One manifestation of this is a strong bid for so-called “defensive” equities, or stocks with low volatility and a high dividend yield. Real Estate Investment Trusts (REITs) are one example of this trend. The thirst for yield has pushed the Dow Jones Select REIT Index up about 20% year-to-date, roughly twice the return of the S&P 500.
We see a similar appetite for income with other yield oriented sectors of the stock market, notably utilities and consumer staples. While the thirst for yield is understandable, it may be leading investors to overpay and take on hidden risks.