Over 20 years ago the Bank of Japan first cut interest rates to zero, a policy adopted in both the U.S. and Europe a decade later during the financial crisis.
Japanese investors have become more attracted to stocks as stocks’ dividend yields rose relative to bond yields.
Investors’ increasing focus on income may lead to long-term shifts in portfolios that favor international stocks.
If Japan represents what the debt and demographic future looks like for many countries, then the future for investors in a world of negative bond yields may lead to more stock market exposure.
Japan as the future
Japan was the first major country to:
- adopt a zero interest rate policy,
- exceed 100% government debt-to-GDP,
- experience an aging population and shrinking workforce.
These milestones have been accompanied by slower economic growth in Japan. Major countries around the world now seem to be following Japan’s lead for interest rates, debt, demographics, and the resulting slower growth.
The aging population of Japan has been focused on investments that satisfy investors’ need for interest income, but Japan’s debt market has little to offer. Japan’s central bank was a pioneer of zero interest rate policy; over 20 years ago the Bank of Japan first cut interest rates to zero. A decade later, during the financial crisis, central banks in both the U.S. and Europe followed Japan’s example.
So where have been investors finding yield? Japan’s 10-year government bond has been yielding less than 2% for over two decades, and has fallen to around zero for much of the past four years. In fact, Japanese bond yields first dipped below dividend yields on stocks in the late 1990s and now dividend yields on stocks exceed bond yields by a record margin, as you can see in the chart below.
Yields on stocks exceeded bonds in Japan for the first time more than 20 years ago
Source: Charles Schwab, Factset data as of 8/30/2019.
If Japan is an example of what the future may hold for many developed countries, the behavior of Japanese investors may signal the future direction of investor behavior around the world.
Over the past 20 years, Japanese investors increasingly allocated their portfolios to stocks for income. As stocks’ dividend yields rose relative to bond yields, stocks have become more attractive investments, as you can see in the chart below of Japanese investors’ allocation to stocks and bonds measured in trillions of yen.
Japanese investors have increasingly favored stocks over bonds for over 20 years
Source: Charles Schwab, Macrobond, Japanese Cabinet Office, Bank of Japan as of 8/30/2019.
The investor shift toward stocks since the early 1990s is echoed in the number of individual shareholders in Japan’s stock market in the chart below. While not an exact count of the number of total investors, it’s a measure of the number of shareholders reported by each company listed on the Tokyo Stock Exchange. Because investors are likely to hold the shares of many companies, there may be some double-counting in the total. Nevertheless, it gives a sense of the direction of the trend in the number of individual shareholders in Japan.
Rising number of individual shareholders in Japan
Source: Charles Schwab, Tokyo Stock Exchange data from 2018 Shareownership Survey published June 26, 2019.
Not just Japan
Unsurprisingly, it seems that the aging population in Japan is choosing stocks yielding 2.4% over bonds yielding -0.3%. Globally, dividend yields are now significantly higher than yields on 10-year bonds, as you can see in the table below.
Stocks’ dividend yields exceed government bond yields in major countries
Source: Charles Schwab, MSCI, Bloomberg data as of 9/2/2019.
The yield advantage for stocks extends to corporate bonds as well. For example, over 95% of European stocks yield more than the Barclays European Corporate Bond Index, as of the end of July, according to Ned Davis Research.
Yet, it remains a hurdle for investors outside of Japan to focus more on the yield rather than the price of stocks and reallocate accordingly. Japan’s households have the lowest allocation to bonds on record, but in contrast, U.S. households’ allocation to bonds is in line with the 60 year average, according to Federal Reserve data.
One reason why investors in other countries may not follow the path of those in Japan and buy stocks for income is a cash cushion. While we have focused on investors’ changing their stock and bond allocation, it may be important to note that Japanese households have traditionally held significantly more cash when compared to households in the U.S. and Europe. That cash cushion may have allowed Japanese investors to tolerate more price volatility from a higher stock allocation in their portfolios without worrying as much during stock market downturns.
International stocks have lagged in recent years measured on the basis of stock prices, but they have outperformed on an income basis Japanese stock have paid out more than U.S. stocks over the past 12 months, producing a yield of 2.4% for the Nikkei 225 Index versus 1.9% for the S&P 500 Index. Looking back more broadly and over the longer-term, international stocks represented by the MSCI EAFE Index have produced a cumulative income return of 17.3% over the past five years, above the 15.8% income return produced by the S&P 500 Index, as illustrated in the chart below.
Measuring income: international outperformance
*Five year period measured from 8/30/2014 to 8/30/2019.
Source: Charles Schwab, Bloomberg data as of 9/2/2019.
Of course, that comparison ignores the price changes—which is hard to do. But, if the future unfolds along the path pioneered (for better or worse) by Japan, investors’ increasing focus on income may lead to long-term shifts in their portfolios that favor international stocks.
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