Page 13 - ISQ UK_October 2017

APRIL 2019

Equity 'Pick-up' Yields

Local dividend yield minus local 10 year bond yield (2019e)

4.00%
3.00%
2.00%
1.00%
0.00%
-1.00%
-2.00%
-3.00%
-4.00%
Switzerland Spain UK Germany France Australia Japan Canada Italy US Emerging
markets

Note: share buybacks are not included
Source: Citigroup, Datastream
aspects and mix in a lower anticipation of any significant Whilst the fixed principle nature of bond investments naturally
quantitative tightening and the result should be lower bond retain some multi-asset class diversification attractions, the
yields, just not this low. absolute low level of many prevailing yields across government
and corporate fixed income markets makes specific bond
Take the ten year U.K. government gilt yield as an example which, selection all-critical. More generally, the attractions of plain old
at the time of writing, is standing at just over one per cent. Brexit cash versus fixed income alternatives, should continue to build
concerns may have impacted anticipated local economic growth given the yield trade-off has compressed and the scope for bond
rates but currently they remain positive... at a time when inflation yields to squeeze back up (meaning capital losses) is very
levels are running above 1.5%. Such analysis draws similar apparent.
conclusions in the vast majority of other major bond markets and
have helped pull down many corporate bond yields materially In short, bonds are a historically popular lower volatility
too. investment that suddenly looks a lot less predictable. Research
with care.
Now, all of this is fine if the bond market is playing a sober
anticipatory game - although the implications are for an imminent
global recession, a point augmented by recent bond yield curve
shifts either at or close to an inverted structure. The trouble is KEY TAKEAWAYS:
such fears appear a little pessimistic especially if sensitive and • The return of the reverse yield gap over the last ten
important world trade talks between countries such as the United years has changed the performance profile of bonds
States and China continue to progress. This combined with a versus equities.
lower dollar gives potential for the world economy to positively • The compression of bond yields can be explained by
surprise, a point potentially picked up by global equity markets the application of quantitative easing and reduced
which had a strong start to 2019 - generally unsurprisingly to an anticipated inflation and economic growth levels.
even more positive extent than any fixed income market. Perhaps
those aforementioned big dividend yields currently available in • Staying overweight equities versus bonds in multi-
many global equity markets are starting to prove suitably asset portfolios remains attractive to us from both an
attractive. income and a total return perspective.
• The scope for bond yields to squeeze back up is
Certainly staying overweight equities versus bonds in multi-asset apparent especially if global growth hopes are
portfolios remains attractive to us from both an income and a boosted by a China-US trade deal and a lower value
total return perspective.
for the dollar.

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