This article is written exclusively for Investing.com.
With some of the highest levels in decades, there is an increasing focus on real returns and real earnings. Therefore, it seems appropriate to examine something else, the real dividend yield of the .
The results are interesting and surprising. When we discount the current value of the consumer price index from the dividend yield of the S&P, it suggests that trouble is ahead for the stock market.
The dividend yield for the S&P 500 is approaching a record low to begin with, even if inflation is not adjusted. Levels not seen since the late 1990s. Not surprisingly, valuations for the S&P 500 reflect the same foam in the market when looking at the index's PE ratio. What's surprising is what happens to the current S&P 500 dividend yield when adjusted for the consumer price index.
The "real" dividend yield of the S&P 500 is currently -4.9%, the lowest level since October 1981. The real dividend yield usually does not reach these levels. In fact, in modern times it has only been lower in 1974 and 1980. Since then, it has never been below -3.1%. That's because every time the dividend yield, adjusted for the CPI, falls below -2.5%, the S&P 500 has a massive market correction, driving the yield sharply higher.
In 1990, 2000 and 2008, real dividend yields fell to -2.7%, -2.6% and -3.1% respectively. What happened next was far from beautiful.
From the summer of 1990 to the fall, the S&P 500 fell nearly 20%. From March 2000 to October 2002, the S&P 500 fell more than 47%. From August 2008 to March 2009, the S&P 500 fell more than 46%. It was no better in 1973 and 1974 when the S&P 500 also fell more than 48%. The 1980 episode seemed to be delayed, and the decline didn't come until 1981, but when it did, the S&P 500 fell nearly 26%.
The only time there was no massive sell-off when real dividend yields fell to -2.5% or more was in 2005.
S&P Dividend Yield/CPI vs. S&P
During any period when real dividend yields fell sharply, this was due to very high inflation and a recession in the US. That's probably why the market didn't correct in 2005, there was no recession. In the other cases, however, there was a recession, with higher consumer prices being the contributing factor. The reason the S&P 500 has likely endured this very low real dividend yield right now is because investors probably still believe that inflation is transient and won't be high permanently. If investors start to think inflation isn't transitory, it could lead to fears of a potential recession.
It is currently unclear whether a recession is imminent. Third quarter growth in the US was much weaker than expected and there are currently signs of slowing global growth. However, there are early indications that growth has recovered strongly so far in the fourth quarter.
If inflation becomes more persistent, leading to a recession like in the past, a strong sell-off in the market will be just around the corner, as always.
