Favour dividend equities as bond yields disappear

Global risk assets sold off on trade war escalation; no trade deal in sight as China is unlikely to cave in to the latest series of tariff hikes.
Chief Investment Office26 Aug 2019
Photo credit: AFP Photo

What happened?  

Another day, another escalation in US-China trade tensions. Global markets switched to a “risk off” mode last Friday (23 August) amid escalating trade tensions between the US and China. In the latest tit-for-tat moves, China announced an additional 5-10% tariff on USD75b of US exports; this was subsequently met with further tariff hikes from the US.

Taking things one step further, US President Donald Trump is threatening to invoke the International Emergency Economic Powers Act that will force US companies to relocate out of China. The S&P 500 Index fell 2.59% overnight while the US Treasury 10-year yield dived to a low of 1.5351% as the flight-to-safety trade took hold.  

What does this mean?

No trade deal in sight; “Tug of War” market to persist. Judging from the latest war of words, we believe the chance of a near-term trade deal is fading. After the recent US manoeuvres on Huawei Technologies Co Ltd and subsequent ratcheting up of tensions, it is unlikely that China will cave in to the latest series of tariff hikes. Recall that in our 2Q19 quarterly publication, “CIO Insights: Lift to Win”, we said that “until we see a comprehensive US-China trade deal, including the lifting of existing tariffs, we do not see equity indices breaking out to new highs”. This is indeed the case, and market volatility is expected to stay elevated.

The race to the bottom: more policy accommodation on the way. Given rising uncertainties, we expect central banks around the world to embark on further monetary easing in the coming months. Already at Jackson Hole, Federal Reserve Chair Jerome Powell said that the Fed “will act as appropriate to sustain the expansion”. This means further monetary easing in the form of rate cuts is on the cards. Over in Germany, with interest rates already in negative territory, the pressure to unleash fiscal easing is on the rise as well.

What should you do?

Sub-zero world – Time to embrace “bond proxies”. On a year-to-date basis, the Japanese Government Bond (JGB) and Bund 10-year yields have fallen by 57 bps on average and they are now languishing at -0.238% and -0.677%, respectively. The volume of negative yielding bonds, meanwhile, has surged by 94% to USD16t this year. Clearly, yield scarcity is on the rise, and generating regular income streams via bond instruments is no longer easy.

In such an environment, we believe portfolio allocators will increasingly shift their funds toward “bond proxies” which are essentially high dividend-yielding equities in defensive and less volatile sectors. The “bond proxies” we favour in our barbell strategy are Asia REITs and China Financials as these segments are yielding c.4%.

We advise investors to increase allocations to such “income equities” to help buffer portfolios in these times of market volatility.

Figure 1: As bond yields head south, investors are set to hunt for yield in dividend equities

Source: Bloomberg, DBS

The information published by DBS Bank Ltd. (company registration no.: 196800306E) (“DBS”) is for information only. It is based on information or opinions obtained from sources believed to be reliable (but which have not been independently verified by DBS, its related companies and affiliates (“DBS Group”)) and to the maximum extent permitted by law, DBS Group does not make any representation or warranty (express or implied) as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions and estimates are subject to change without notice. The publication and distribution of the information does not constitute nor does it imply any form of endorsement by DBS Group of any person, entity, services or products described or appearing in the information. Any past performance, projection, forecast or simulation of results is not necessarily indicative of the future or likely performance of any investment or securities. Foreign exchange transactions involve risks. You should note that fluctuations in foreign exchange rates may result in losses. You may wish to seek your own independent financial, tax, or legal advice or make such independent investigations as you consider necessary or appropriate.

The information published is not and does not constitute or form part of any offer, recommendation, invitation or solicitation to subscribe to or to enter into any transaction; nor is it calculated to invite, nor does it permit the making of offers to the public to subscribe to or enter into any transaction in any jurisdiction or country in which such offer, recommendation, invitation or solicitation is not authorised or to any person to whom it is unlawful to make such offer, recommendation, invitation or solicitation or where such offer, recommendation, invitation or solicitation would be contrary to law or regulation or which would subject DBS Group to any registration requirement within such jurisdiction or country, and should not be viewed as such. Without prejudice to the generality of the foregoing, the information, services or products described or appearing in the information are not specifically intended for or specifically targeted at the public in any specific jurisdiction.

The information is the property of DBS and is protected by applicable intellectual property laws. No reproduction, transmission, sale, distribution, publication, broadcast, circulation, modification, dissemination, or commercial exploitation such information in any manner (including electronic, print or other media now known or hereafter developed) is permitted.

DBS Group and its respective directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned and may also perform or seek to perform broking, investment banking and other banking or financial services to any persons or entities mentioned.

To the maximum extent permitted by law, DBS Group accepts no liability for any losses or damages (including direct, special, indirect, consequential, incidental or loss of profits) of any kind arising from or in connection with any reliance and/or use of the information (including any error, omission or misstatement, negligent or otherwise) or further communication, even if DBS Group has been advised of the possibility thereof.

The information is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. The information is distributed (a) in Singapore, by DBS Bank Ltd.; (b) in China, by DBS Bank (China) Ltd; (c) in Hong Kong, by DBS Bank (Hong Kong) Limited; (d) in Taiwan, by DBS Bank (Taiwan) Ltd; (e) in Indonesia, by PT DBS Indonesia; and (f) in India, by DBS Bank Ltd, Mumbai Branch.