Sharemarket yield gets a second look amid bond moves

The yield from share market ‘defensives’ is suddenly in focus as bonds look like disappointing for the third year in a row.

The threat for retail assets is, of course, a big dip in consumer spending.

Twelve months ago, a temporary peak in global bond yields provided the green light for a strong relief rally in sharemarkets. That relatively close relationship has remained in place since, up until last week.

Before last week, the relationship between bond markets and shares looked straightforward and simple: bond yields up, shares down; bond yields down, shares up.

This close relationship explains why any form of bad news has proved positive for shares since. For example, rising risks for US regional banks and the subsequent Fed response resulted in lower bond yields. Outcome: shares up.

We will need to see a convincing signal that Israel’s war on Hamas is not leading to a much broader geopolitical conflict in the Middle East before sharemarkets can show the same kneejerk response to retreating bond yields this time around, which, fingers crossed, will be the case.

But maybe the most important signal is that falling bond yields are not under all circumstances a positive for the direction of sharemarkets. The next challenge might come with much slower economic momentum, which also should lead to lower bond yields, but not by default to rising share prices.

Looking at the bigger picture, higher bond yields are a form of tightening, thus placing more pressure on the US economy. It’s only common sense that all the talk of higher-for-longer and the subsequent move up in longer-dated Treasuries is narrowing the odds for the US economy to run out of steam in the quarters ahead.

For market investors, the big disappointment in the past two years include the notable underperformance of defensives, quality growth and the smaller-cap segments of the sharemarket. And those who positioned for lower bond yields have been taken to the cleaners over the past weeks.

The fact so many investors in fixed income are left with negative returns and bruised souls would explain a lot of what has occurred. When bond yields rise rapidly, it means bond prices are selling off.

In fact this represents some of the worst experiences for fixed-­income investors in our lifetime; possibly the worst ever.

As things stand, 2023 will be the third consecutive year of negative return (mark-to-market) for bond investors. This has never before happened, ever.

Sharemarket choices

Over in the US, high-yielding corporate bonds are now offering yields of 9 per cent-plus and as GMO’s Jeremy Grantham opined recently, if one’s worried about large-scale corporate debt defaults next year, imagine what the impact would be on the sharemarket generally.

A corporate bond is essentially a contract to pay back the full amount upon expiration, plus all obligatory intermediate payments, effectively cushioning the investor from fluctuating prices as long as he/she holds until ­maturity. This is not the case when one buys an ETF that combines a multitude of such bonds.

High-yielding corporate credit trades like equity. Something to keep in mind for investors looking to explore this freshly emerging opportunity.

The local sharemarket these days offers a multitude of high-yielding options, which would including property trusts or REITs.

One outstanding problem with office REITs trading at significant discounts is the uncertainty surrounding future valuations for ­office assets that might no longer be in as high demand in the years ahead. Higher costs to service debt are shaping as the key growth limit for many a REIT locally as well as internationally.

The threat for retail assets is, of course, a big dip in consumer spending, even without an economic recession. The offset remains that current discounts are likely to prove excessive.

If you look at something like the HomeCo Daily Needs REIT (which is included in the FNArena/Vested Equities All-Weather Model Portfolio), on current pricing and forecasts, the annual yield is in excess of 7 per cent, and expected to rise.

Separately, a number of investors have approached me in the weeks past, some worried about what has been happening with share prices of CSL which is one of the leading stocks in Australia that is not sold on the basis of yield. In fact chairman Brian McNamee recently said CSL was “never going to be a dividend stock”.

So what is happening to CSL?

The short answer is hedge funds and other market participants are looking for victims of the new anti-obesity “wonder drugs” from Novo Nordisk and Eli Lilly that are conquering the US by stealth.

These so-called GLP-1 drugs are, essentially, heavy-handed suppressants and those on it experience a sharp loss in appetite for food and drinks, with follow-through impacts on, for example, snacking, gambling and even shopping/spending in general.

Extrapolate the impact and just about every consumer-oriented business might be affected. The average food-related business in the US has seen its share price dive by 26 per cent in recent weeks.

The heaviest impact on the ASX has thus far been reserved for healthcare companies CSL and ResMed.

Rudi Filapek-Vandyck is editor at sharemarket research service fnarena.com.