Yield plays to gain from dovish central banks

Asia and Europe dividend equities offer attractive yield spreads and have outperformed since GFC, while exhibiting lower volatility than market benchmarks.
Chief Investment Office04 Apr 2019
Photo credit: AFP Photo

In the latest 21 March Federal Open Market Committee (FOMC) meeting, the Federal Reserve surprised markets with its dovishness. Fed officials were not looking to hike rates for the rest of 2019, compared to the market consensus of one rate hike. But this dovishness is not a new phenomenon around the globe.

Earlier in March, the European Central Bank (ECB) delivered a policy U-turn with fresh stimulus plans, despite wrapping up its bond-buying programme in December 2018. At the same time, the ECB held its negative rate stance and pushed the prospect of an interest rate hike even further.

In Japan, the Bank of Japan (BOJ) kept its ultra-dovish monetary policy unchanged, while downgrading its assessment of the Japanese economy. Inflation in Japan has been stubbornly low. There are now talks of the BOJ ramping up further monetary stimulus, to aid the slow growth and persistently low inflation.

There is, however, one problem – the BOJ’s asset hoard, after years of quantitative easing, is now larger than its economy. What’s more, there is little sense where the limit stands for the BOJ.

Indeed, more than a decade after the global financial crisis (GFC), the G-3 central banks are still caught in uber-dovish land. With negative interest rates plaguing global financial markets, many global institutional investors are left with few choices when seeking yield.

The hunt for yield is on. This ultra-dovish stance by global central banks has directly led to an atypical phenomenon – USD10t worth of negative-yielding bonds (Figure 1). These are bonds where debt issuers are paid to borrow, and buyers pay (instead of receive) interest. Such bonds make up about one-fifth of the world’s broad investment grade (IG) market value today – a two-year high – pushing investors to take on more risky assets. We advise investors to seek yield in less crowded  places.

Figure 1: Value of negative yielding bonds hit a two-year high

Source: Bloomberg, DBS

Europe, Hong Kong, and Singapore stand out. With interest rates in G-3 likely to stay lower for longer, and 20% of the global IG market value now in negative yielding territory, investors are hunting for alternatives to deploy their cash. Where can investors find yield then?

Asia and Europe provide fertile hunting grounds for dividend yield, with the MSCI Asia ex-Japan and MSCI Europe offering decent dividend yields of 2.7% and 3.8%, respectively. Indeed, we think yield plays in Asia and Europe should benefit from global central banks’ dovish tilt, and the attractive yield spreads on offer. Against the German 10-year bund, which currently yields -0.07%, the yield pick-up of 3.9% offered by Europe equities looks attractive. Within Asia, Singapore and Hong Kong are favourable stand-outs, in terms of yield spreads (Figure 2).

Figure 2: Attractive yield spreads on offer in Europe, HK, and SG

Source: Bloomberg, DBS

Dividend equities in Asia and Europe have outperformed since GFC.  Dividend stocks in Asia and Europe have generally outperformed their respective benchmark indices since 2009, and with less volatility (Figure 3). In Asia Pacific ex-Japan, dividend plays have outperformed their market benchmark by 9.6% since the end of the GFC. Similarly in Europe, dividend plays have outperformed their market benchmark by 43.9% since 2009.

Both Asia Pacific ex-Japan and Europe dividend plays also boast a lower historical beta, compared to their market benchmark. The Singapore real estate investment trust (REITs) sector, for one, has proved to be more resilient than the benchmark during market downturns, while generally outperforming the market benchmark during upcycles (Figure 4). Indeed, dividends as a source of total returns cannot be underestimated, given the fact that they made up 65.5% of Europe’s total returns and 44.4% of Asia Pacific ex-Japan’s total returns since 2009.

Figure 3: Dividend plays stand out in terms of returns and volatility

Source: Bloomberg, DBS

Figure 4: S-REITs – resilient in downturns, outperforming the Straits Times Index (STI) in upturns

Source: Bloomberg, DBS

Sectors to seek dividends and cashflow, as part of barbell strategy. Where, then, should investors be hunting for dividends in Europe, Hong Kong, and Singapore? In Europe, investors should seek out Europe stocks with high free-cashflow yield, a recurring income base, and attractive dividends. In Asia, China banks and Singapore REITs are traditional dividend strongholds and therefore attractive for dividend hunting.

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