In a scenario where the yield gap is negative, investors typically expect which of the following?

• A. Dividends to increase in the future.
• B. Inflation to fall.
• C. Bond yields to rise.
• D. Inflation to rise.

Answer: (A)

The main idea is how the relative income from stocks compares with that from bonds. The yield gap looks at the dividend yield of equities versus the yield on bonds. When that gap is negative, bonds are offering more income than equities right now. In this situation, investors expect equities to compensate by increasing future dividend payments. Higher dividends would raise the dividend yield over time and help close the gap, making equities more attractive again.

Inflation movements or bond yields aren’t the direct implication of a negative yield gap in this context, and a rise in bond yields would typically widen the gap rather than resolve it. The key takeaway is the expectation of higher future dividends to restore a competitive income stream from stocks.