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Negative Interest Rates And The Future Of Investing

Key Points
  • 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

MSCI Japan dividend yield vs Japan 10-year yield

Source: Charles Schwab, Factset data as of 8/30/2019.

Investor shift

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

Japan household assets and debt securities

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

Shareholders on Tokyo Stock Exchange

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

Dividend yield table

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. 

Cash cushion

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 outperformance?

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

International income performance

*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.

What You Can Do Next

A Total-Return Approach for Retirement Income
IRA Taxes: Rules to Know & Understand
IRA Tax Traps

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.  Investing in emerging markets may accentuate these risks.

The MSCI EAFE Index is an equity index which captures large and mid-cap representation across 21 Developed Markets countries around the world, excluding the US and Canada. With 924 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI Japan Index is designed to measure the performance of the large and mid cap segments of the Japanese market. With 323 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Japan.

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

The MSCI Austria Index is designed to measure the performance of the large and mid cap segments of the Austrian market. With 6 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Austria.

The MSCI Belgium Index is designed to measure the performance of the large and mid cap segments of the Belgium equity market. With 10 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Belgium.

The MSCI Canada Index is designed to measure the performance of the large and mid cap segments of the Canada market. With 90 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Canada.

The MSCI Denmark Index is designed to measure the performance of the large and mid cap segments of the Danish market. With 17 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Denmark.

The MSCI Finland Index is designed to measure the performance of the large and mid cap segments of the Finnish equity market. With 12 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Finland.

The MSCI France Index is designed to measure the performance of the large and mid cap segments of the French market. With 79 constituents, the index covers about 85% of the equity universe in France.

The MSCI Germany Index is designed to measure the performance of the large and mid cap segments of the German market. With 64 constituents, the index covers about 85% of the equity universe in Germany.

The MSCI Ireland Index is designed to measure the performance of the large and mid cap segments of the Irish equity market. With 7 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Ireland.

The MSCI Italy Index is designed to measure the performance of the large and mid cap segments of the Italian market. With 24 constituents, the index covers about 85% of the equity universe in Italy.

The MSCI Netherlands Index is designed to measure the performance of the large and mid cap segments of the Netherlands market. With 20 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Netherlands.

The MSCI Norway Index is designed to measure the performance of the large and mid cap segments of the Norwegian market. With 10 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Norway.

The MSCI Portugal Index is designed to measure the performance of the large and mid cap segments of the Portuguese market. With 3 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Portugal.

The MSCI Spain Index is designed to measure the performance of the large and mid cap segments of the Spanish market. With 22 constituents, the index covers about 85% of the equity universe in Spain.

The MSCI Sweden Index is designed to measure the performance of the large and mid cap segments of the Swedish market. With 32 constituents, the index covers about 85% of the equity universe in Sweden.

The MSCI Switzerland Index is designed to measure the performance of the large and mid cap segments of the Swiss market. With 39 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Switzerland.

The MSCI United Kingdom Index is designed to measure the performance of the large and mid cap segments of the UK market. With 97 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the UK.

The MSCI USA Index is designed to measure the performance of the large and mid cap segments of the US market. With 637 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.

(0919-9DHR)

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