Central banks are increasingly controlling volumes and prices as they attempt to set the shape of yield curves.
In the US, investment grade 10-year corporate bonds typically offer more than a 2 per cent yield, significantly higher than the 10-year Treasury yield of approximately 0.7 per cent. It was therefore a curious recent move by the US Federal Reserve to target corporate bonds. What is the Fed seeing that spooked it to take such action? Restoring liquidity to credit markets was one cited reason, but regardless of the motivation the end outcome is clear – corporate bond yields are likely to fall, potentially closing off an additional asset class offering income to ever-hungry investors.
It’s a similar theme at home, where the Reserve Bank of Australia (RBA) has pushed interest rates so low that as an asset class, term deposits are no longer an option for investors requiring income.
In response to COVID-19, on 19 March 2020 the RBA announced a cut in the overnight cash rate target to a record low of 0.25 per cent. In fact, the RBA went one step further and announced it would also target a yield on three-year Australian government bonds of 0.25 per cent, purchasing across the yield curve to achieve the target.
This unconventional measure is set to remain in place until progress is made towards the RBA’s goals of full employment and the inflation target (2-3 per cent on average, over time).
Given the spike in unemployment due to COVID-19 and the risk of further increases once the government’s stimulus measures (JobKeeper and JobSeeker) are wound back, combined with persistently low inflation, achieving these goals does not appear likely anytime soon. In fact, at the ANU Crawford Leadership Forum on 22 June 2020, RBA governor Philip Lowe said that due to the pandemic and an excess of global savings relative to investments, interest rates would remain at their current record lows for years to come.
Looking outside the box
To us at Kardinia, yield-producing equities are increasingly looking like the last asset class standing. We believe investors will continue to move capital into equities to chase yield in a world seemingly devoid of such opportunities. The need for income is a powerful force – particularly for those transitioning to or already in retirement – and at some point, we believe this need will tip bond investors into the equities market. Consequently, we have increased our exposure to this thematic.
Traditional yield investors typically target low growth defensive sectors like property, infrastructure and utilities, whereas growth investors target stocks with high earnings growth. We own traditional yield stocks such as Charter Hall and Atlas Arteria, but have increasingly turned to non-traditional yield stocks such as JB Hi-Fi and Fortescue. In this environment, these two companies are now offering attractive dividends with dividend certainty due to strong and resilient earnings. Fortescue is one of the few stocks in the Australian market which could surprise to the upside on its final dividend due to strong iron ore prices. JB Hi-Fi’s divided yield this year is forecast to be around 4 per cent – driven by government stimulus, a product offering for the times (home office, entertainment) and an increasing online presence – and we believe there is little risk of this being cut.
Share trading at a record high
At a time when investors are grappling with unprecedented uncertainty, a new phenomenon is taking hold in equity markets which is causing quite a stir.
Retail investors are setting up accounts and trading securities with enormous enthusiasm. A range of online trading platforms, such as Robinhood, are being embraced by a new generation of retail investors. Populist investment forums are encouraging investors to participate and with a lack of sport, gambling and other entertainment options available, combined with increased free time, many have turned to share trading.
The impact on markets has been noted. The Australian Securities and Investments Commission’s recent report, Retail investor trading during COVID-19 volatility, highlights the doubling of average daily securities market turnover by retail brokers: between 24 February 2020 (the first trading day after the market peak) and 3 April 2020, it rose from $1.6 billion to $3.3 billion.
Whether this retail trend has truly divorced fundamentals from asset prices, or whether the professional investment community is clutching at explanations for the recent market moves, is open to much debate. Either way, Kardinia believes central bank actions remain the most powerful driving force behind market returns.
Kristiaan Rehder, portfolio manager at Kardinia Capital