Apologies for the radio silence last week – manic with the AltFi London summit, which was a big success. Thank you to all those that attended. Anyway back to normal business….
Markets are spooked again. They’ve spent the last few months hoping that the US Federal Reserve will slow down the pace of rate increases and now that they’ve obeyed, investors are worried that the real reason is that the Fed is seriously worried about a slowdown. Cue Emily Maitlis style roll of eyes. There were also two big surprises last week: a much more dovish-than-expected Fed; and a big miss on Euro Area manufacturing PMIs. I’d also echo Mark Glowrey’s (of City and Continental) comments which is that US 10y bond yields have fallen over 15bps since the Fed meeting this week and are over 30bps below early March levels while the “Bund (10yr) has moved back into negative territory, around -1bp this morning whilst the JGB will cost you nearly 10bp a year to own. Further afield, I see that the 10yr Australian bond yield has dropped to record lows (1.78%). In the States, the talk on the financial media is of curve inversion, with commentators highlighting the ratio between the 3-month bill and the ten-year. Bond futures positioning and 10y yields have been tightly correlated and a move all the way back to neutral suggests further downside, to 2.2%.”
Is this our first really big sign pointing to a slowdown? My own hunch – and it is just guesswork – is that its another of those softenings which will fade away in three to six months. So, probably no big sell off…yet. Analysts at Deutsche Bank in the US also reckon that we’re in for a bit of turbulence in equities, but we should be fine. In their latest weekly positioning note for clients, they suggest that the “ 3 month gap since the sell-off in late December is now at the upper end of the 2-3 month duration between modest sell-offs (3-5%) historically. However, with positioning not yet elevated and very little prior inflows, any equity sell-off should remain modest absent large negative catalysts. Vol Control funds have allocations near the top of their range and risk remains to the downside with some marginal selling today as volatility spiked. The CTA complex has become more long S&P 500 on the sustained rally but positioning is still light relative to 2017 and early 2018. Equity exposure for Risk Parity funds meanwhile is still very light relative to history.”
Sticking with the equities side of the fence, what does this bout of nerves tell us about value stocks? This gaggle of cheap stocks was supposed to do well in a rates tightening environment – will they tank now that rates might start falling? Andrew Lapthorne at SocGen (something of a value enthusiast, most of the time at least) is ambivalent. He observes that “value was hit hardest in last week’s sell-off, which is not surprising given their macro sensitivity and therefore inverse relationship to bonds. We have been arguing that Value was attractive as a hedge against rising bond yields, and of course, bond yields have been going down not up, but we have also been arguing that Value stocks are ‘cheap’ – a view that hasn’t changed despite the many obvious fundamental risks attached to them. We think this ‘cheapness’ might reduce downside risks in an economic slowdown and more importantly spell greater upside if, just as in 2016, policy makers change tack. Chasing the already expensive “bond proxy” stocks, i.e., those stocks most correlated to falling bond yields introduces too much bond risk into your asset mix. “
In this environment perhaps the best thing is to seek safety in a combination of steady, growing dividends and a quality business franchise. That’s certainly the strategy promoted by Andrew Lapthorne’s Quality and Income funds which have captured a large chunk of index tracking money. Back in active fund management land Evenlode, a young asset management firm based out in deepest Oxfordshire has come out with their Global Dividend Sustainability Report – a bunch of ten businesses whose average yield is around 2.4% and which offer investors a robust business franchise. Key criteria to get on the global list includes:
- strong competitive positions in their respective disciplines – quality compounders (Cash ﬂow return on invested capital (CFROIC))
- Low debt (the average is 0.7 x net debt to EBITDA)
- Strong free cashflow cover (FCF/Dividend)
- Strong dividend history (minimum 2% yield)
And here’s the final ten – see graphic below.
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