High Yields Around the World
06/24/2009 10:27 am EST
Alexander Young, international equity strategist for Standard & Poor's, says equities have rallied more outside the US, but yields are higher there as well.
After roaring ahead in March, April, and May, the pace of the global equity rally slowed in June, most notably in developed markets. Investors have become more sensitive to rising commodity prices and long-term interest rates after a sharp jump in valuations, both of which threaten to derail the fragile US and European recoveries. These factors represent a bigger headache for developed markets, where ten-year government bond yields are up significantly since risk aversion peaked in early March.
By contrast, emerging market (EM) sovereign bond spreads over Treasuries have narrowed to 427 basis points from a peak of 901 on October 24, 2008 amid declining risk aversion. In addition, the commodity price increase disproportionately benefits emerging markets, as roughly 50% of emerging markets' earnings comes from the energy and materials sectors, which together comprise one-third of EM equity market cap.
After lagging the Standard & Poor's 500 all year, the MSCI EAFE index, a developed international equity benchmark, recently overtook the US index. Nascent developed international outperformance coincided with a sharp sell-off in the US Dollar index since mid-May.
The dollar's weakness was fairly broad based, with the greenback declining against a wide array of both developed and emerging market currencies. As a result, dollar-denominated equity returns in many major overseas equity asset classes got a boost.
This trend has been most notable in the emerging market asset class, with the MSCI
Emerging Markets index-the dollar has generally been weakest vs. developing nations' currencies when global risk-aversion is declining and commodity prices are on the rise
Nevertheless, EM equity performance has cooled as well, as the asset class's exports remain vulnerable to prolonged economic weakness in the US and Europe. With global stocks markets priced for a resumption of both global gross domestic product (GDP) and earnings per share (EPS) growth by the first quarter of 2010, it is not surprising to see the rally falter in the face of new fundamental risks. If a return to positive GDP and EPS growth fails to materialize, equities are currently more expensive than they appear. While yield is only one consideration, with future capital appreciation likely to moderate, we believe dividends will be an increasingly important component of total return.
International equities generally offer higher yields than their US counterparts, with the iShares MSCI EAFE Index (NYSEArca: EFA) currently yielding 3.9% versus 2.86% for the S&P 500. At the regional level, Europe and developed Asia (except for Japan) sport the highest payouts, [while] at the country level, iShares MSCI Spain's (NYSEArca: EWP) 6.8% yield is currently the highest in the developed world, and iShares MSCI Taiwan (NYSEArca: EWT) and iShares MSCI Australia (NYSEArca: EWA) are close behind at 5.5%.