Dividend, Bund yield gap hits record high
* Historically, Bund yields higher than dividend yields
* For yield hunters, stocks never been so cheap vs bonds
* Pension funds closely watching spread as a valuation tool
By Blaise Robinson and Scott Barber
PARIS, June 7 (Reuters) - The gap between the dividend yields on the euro zone's top companies and the return on German government debt is at a record high, prompting some to bet on the spread snapping back, by scooping up stocks or using derivatives.
A steep drop in share prices since mid-March combined with unrelenting demand for low-risk Bunds has driven the spread between the two yields to its widest since Thomson Reuters started tracking the data in 2001, even wider than when it spiked at the height of the financial crisis in early 2009.
With the euro zone's Euro STOXX 50 index offering an average yield - dividend per share divided by price per share - of 4 percent and 10-year Bund yields at 1.2 percent, the spread is around 280 basis points.
Unlike in 2009, the gap has been gradually widening over the past months, to reach the current "huge" spread, said Eric Galiegue, head of Valquant, a Paris-based financial research firm.
"It reflects all the systemic fears out there, such as the implosion of the euro zone. It's a sign that investors' capitulation is close, which should be followed by historic buying opportunities in equities," he said.
The spread is an often used valuation measure, particularly for long-term investors such as pension funds. With Bunds usually historically yielding more than stocks, some see the current gap in favour of dividends as a buy signal for stocks.
Over time, the spread would be expected to revert towards the long-term average from today's extreme levels.
"In that context, playing the 'mean reversal' makes a lot of sense. Think about it: companies are healthy, a lot of them have strong exposure to foreign markets, and their stocks have never been so cheap compared to Bunds, which are extremely expensive," Galiegue said.
The average corporate dividend yield moved above the Bund yield in 2008 but really started to widen in mid-2011, with yields on Bunds, seen as a safe haven from the euro zone debt crisis, plunging below 2 percent and the dividend yield moving towards 4 percent.
"LESS RISKY" DERIVATIVES PLAYS
To play a potential "mean reversal", investors unwilling to yet dip their toes back into the stock market could use a less volatile derivative pairs trade.
"You sell Bund futures and in front of that, you buy dividend futures, with maturities at the earliest in December 2012 to give things a bit of time to settle down. This makes a nice spread," said David Thebault, head of quantitative sales trading, at Global Equities.
Dividend futures, which trade in dividend points and not yields, are relatively stable "so even if stock prices go further down in the next few months, you're not suffering", Thebault said.
For investors willing to take more risk, they can add Euro STOXX 50 futures to the mix to get exposure to a potential relief rally in stocks in the next few months.
"If you feel it's time to turn 'contrarian' in the current negative mood, you buy one Euro STOXX 50 futures contract for each dividend futures contract to make sure you catch the wave when it comes, but with less risk than by buying stocks directly," Thebault said.
For Valquant's Galiegue, however, the best way to play this extreme spread is simply to move out of Bunds and start buying equities with a time horizon of two to five years.
"For investors able to stomach a another few months of roller-coaster markets, this may turn out to be the time to buy. Down the road, stocks could double or even triple during the next five years."
"NOT ALL DIVIDENDS ARE EQUAL"
Top euro zone blue chip dividend payers include utility GDF Suez and Deutsche Telekom, with yields of 9 percent. Even the lowest payouts on the Euro STOXX 50, from LVMH and L'Oreal, at about 2.3 percent, are higher than current Bund yields.
It means investors buying shares of GDF Suez or Deutsche Telekom now would get a return of 9 percent over the next 12 months, on top of a potential recovery in currently depressed share prices.
"But not all dividends are equal," warned Frederic Biraud, head of B*Capital, a Paris-based brokerage and wealth management firm.
"For some companies, the dividend payout is too high and we expect cuts on that front, especially from embattled Spanish companies," he said.
"It's best to look for growth stocks that also offer good dividends, and not purely hunting for the biggest yields, which could turn out to be value traps."
Although doubts remain over the capacity of a number of companies, particularly in the banking sector, to maintain their dividend payouts, investors were relieved to hear BNP Paribas , France's biggest listed bank, saying it hopes to actually increase its payout after 2012.
However, Henri Chabadel, head of sigma asset allocation at Groupama Asset Management, warned that the dislocation in historical correlations between the different asset classes should not been seen as a temporary hiccup, as things are not about to go back to more "normal" patterns.
"The turbulence will last for much longer than what most people anticipate. The problems faced by Europe are structural, and it will take time to fix them. Simply injecting massive liquidity won't do the job. This might just be the 'new normal'," he said.
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