When cash is no longer trash

With the Federal Reserve raising rates over the past couple years and the stock market moving higher, the yield on 1-Year T-Bills now exceeds the dividend yield on $SPX. As can be seen on the following chart, the ratio of the 1-Year T-Bill yield to $SPX dividend yield is now 1.46.

Div Yield

This is not high by historical standards. The average ratio since 1970 is 1.78, so it is still below average.

I drew an arbitrary line on the chart at 2.75. This has been an approximate peak level on a number of occasions.

I looked at all new instances since 1970 where the ratio first hit 2.75 (had not been at or above 2.75 within the prior 6 months). The following table shows these occurrences, as well as the most proximate recession.

Yield and Recsession.JPG

The next table shows the 1, 2 and 5 year price returns for $SPX following these occurrences as well as the max drawdowns in the subsequent 5 years.

Yield an d

From the table we can see that the ratio has hit 2.75 in the 1-5 years that have preceded the largest drawdowns since 1970. With the exception of the late nineties, where the ratio surged all the way to 5.75 and the market did not put in a meaningful top for just over 3 years, a significant market top and drawdown occurred within a couple of years.

Assuming that the Federal Reserve continues to tighten at its anticipated pace, and the market stays flat, it is likely that we will hit the 2.75 ratio some time in 2019. What would happen after is not possible to predict with this historical information and such a small sample size, so I would certainly not be rushing to short the market if we were to get to that level solely based on this historical information. There is nothing to say that the ratio could not go to 5.75 again like in the late nineties, or even beyond. It is also possible that the ratio could peak lower than 2.75 in this cycle.

However, I think that psychologically a 1-Year T-Bill rate that is almost 3 times the $SPX dividend yield would cause people to think twice about holding stocks, especially given current valuations. Risk of a large drawdown would be elevated in my opinion, so at the very least caution would be warranted. I will revisit this if it occurs.