Are High-Yield Stocks in Bubble Territory?

Investors have been flocking to high-dividend-paying stocks, lured by their predictable, bondlike income and downside defenses. But investors may be getting more risk than they bargained for.

The widespread pursuit of safety in high-yielding stocks has driven up their valuations and increased market concentration in these stocks. It has also caused an alarming surge in their correlation to bonds, so investors may be getting a lot less diversification than they realize. 

Let’s look at valuations first. High-yield stocks are as pricey as they’ve been since the early 1950s, trading at a modest premium to the market versus a long-term average discount of 20%. We don’t view this premium as exorbitant given the current market anxieties, but it does limit upside potential and makes these stocks more vulnerable than others if sentiment turns. Most of the high-priced dividend-paying stocks are in mature, slow-growth sectors such as consumer staples, telecom and utilities, which are likely to look less appealing than more economically sensitive stocks in a sustained economic recovery.

What’s more, high-yield stocks now account for a much bigger share of the market, elevating the risk that arises when the market becomes overly concentrated in an overpriced subset—such as technology stocks in the late 1990s. In the US, where this trend is most pronounced, stocks with yields 20% or more above the market’s now account for 44% of the S&P 500 Index on a cap-weighted basis. That’s their highest share in the last three decades and well above the historical average of 36%, as shown in the display just below.

High-Yield  Stocks Consumer Record-High Share of Market

More menacing is the extent to which high-yielding stocks are behaving like bonds. Correlations between the relative returns of the highest-yielding S&P 500 stocks and total returns of 10-year US Treasuries have soared to 80% on a two-year-trailing basis. That’s more than 11 times its historical average of 7%, as shown in the second display, below. That’s the highest it’s been in more than 60 years. This means high-yield stock investors may be far more exposed to bond-market risks—such as an eventual rise in interest rates—than they want to be.  

Is There Two Much Bond Best in Your Equity Alpha?

Investors need to understand the growing risks of overplaying the defense card. As a countermeasure, they may want to add more cyclical, deeper-value names that have been lagging on doubts about the economic recovery and future earnings. In our view, these will also enhance their equity alpha potential. When recovery comes, we expect these overly cheap stocks, many of them in better financial shape than before the crisis, to lead.  

Investors who are passively invested in cap-weighted indices should pay attention to these trends, too, because the market embeds the growing dangers of overexposure to expensive safety stocks and higher-than-usual correlations to the bond market. Active investing strategies, backed by research, can take advantage of the opportunities these distortions create—and can avoid some of the risks.   

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Joseph Gerard Paul

Chief Investment Officer—Strategic Equities and US Value Equities
Joseph Gerard Paul serves as Chief Investment Officer for Strategic Equities, appointed in 2014, and US Value Equities, appointed in 2009. He has also served as CIO of the Advanced Value Fund since 1999. Paul was previously CIO of Small & Mid-Cap Value (2002–2008) and co-CIO of Real Estate Investments (2004–2008). Additionally, he was the director of research for the Advanced Value Fund for two years. In that role, Paul was instrumental in the genesis of the Advanced Value leveraged hedge fund. He joined Bernstein in 1987 as a research analyst covering the automotive industry, and was named to the Institutional Investor All-America Research Team every year from 1991 through 1996. Before joining the firm, Paul worked at General Motors in marketing and product planning. He holds a BS from the University of Arizona and an MS from the Massachusetts Institute of Technology’s Sloan School of Management. Location: New York

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