Favour dividend equities as bond yields disappear
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
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