The perfect hands-free investment plan is to buy dividend stocks with an attractive dividend yield, sit back and watch the income flow. Such a strategy requires little or no input from the investor.
However, in today’s low-interest rate world, a passive dividend income strategy has become an unattainable goal. At the time of writing, the US 10-year Treasury yield stands at 1.53%, and the average yield for the S&P 500 is not much higher at 2.04%. That’s less than half the mean S&P 500 dividend yield of the past 150 years. The mean dividend yield for the S&P 500 since 1871 is 4.39%.
Unable to find much in the way of yield anywhere else, investors, traders and analysts are turning to exotic methods to produce income.
The hunt for yield could impact market stability
One of the more popular strategies is selling volatility to enhance yield, and this strategy has now reached an extreme level. Research from Bank of America published earlier this week titled “Dangerous yield chasing” shows that selling vol to enhance yield is now at an extreme level, with net speculative VIX exposure at all time shorts. Selling volatility can be a profitable strategy when volatility is elevated, but volatility is currently at some of the lowest levels printed this year.
Indeed, the Wall Street Journal published an article this morning claiming that the past 30 days have been the least volatile of any 30-day period in more than two decades the S&P 500. On Friday the CBOE VIX index on Friday dropped to levels last seen in the summer of 2014.
This really isn’t an attractive environment for selling vol. Selling at current levels will expose investors to highly asymmetric risks although it seems many investors aren’t worried about this and expect subdued volatility to continue for some time. CFTC positioning data reveals the shortest speculative positioning in VIX futures of all time.
VIX positioning isn’t the only trend that is worrying Bank of America’s analysts. The relative level of cross-asset volatility is back to summer 2014 levels, just before the central bank diversion story began. Low levels of cross-asset volatility imply that the reach for yield is driving investors further afield than just VIX selling, crowded short positioning across the volatilities of numerous assets is indicated, which is massively concerning.
Crowded short positioning across volatilities implies that when the next market shock arrives, a volatility spike will be elevated by cross-asset correlations increasing the likelihood that an idiosyncratic risk affects all other assets. Put simply, volatility selling inspired by the reach for yield could pose a systematic risk to the financial system as it will quickly turn any small localised market event into a broad market sell-off spanning across asset classes.