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The often inverted logic of markets

What is risky, and what is secure?
With the pressure on share prices, some quality South African names are now trading on extremely attractive yields. Image: Shutterstock

In the second half of last year, global bond markets reached extraordinary levels.

Around $15 trillion worth of government bonds were trading on negative yields. In other words, investors buying this debt were prepared to pay governments to lend them money.

This negative yielding debt represented around 25% of the total market, and had accumulated in a little over five years. For most of 2014, there was not a single bond yielding less than 0%.

Total negative debt in the world

Source: Deutsche Bank

Three examples illustrate just how extreme this environment had become:

In August, Germany raised €800 million by issuing a 30-year bond at zero interest.

In other words, the German government borrowed nearly a billion euros for three decades without having to pay back a cent more than the capital amount.

Around the same time, Switzerland’s 50-year bond yield fell below 0%. Investors were therefore prepared to give the Swiss government their money for half a century and accept less than their original capital back in return.

European 30- and 50-year bond yields

Source: Thomson Reuters

Finally, Austria had issued a 100-year bond in 2017 at a yield of 2.1%. By September last year, the yield had fallen to 0.62%.

At that rate, investors were committing their money for 98 years and not even getting double the amount back. If inflation in Austria remained at its current level of around 1.7%, they were ensuring that they would earn a real loss over this period.

What’s happening?

The reason yields could go so low is because of how uncertain many investors are about the global economic outlook. Investors are prepared to take these relatively small losses over even very long periods rather than risk-taking larger losses elsewhere.

“Bonds are effectively a proxy for investors’ assessment of the possibility of growth, inflation, and therefore interest rates either rising or falling in the future,” explains James Molony of Schroders. “If bonds are in demand at low yields, the implication is that investors see little prospect of rising inflation or rates.

“In fact, negative yields suggest investors think rates need to fall, which means they see a risk of deflation, whereby prices of goods and services fall.”

Yet in this environment, South African 10-year government bonds were yielding between 8% and 8.5%. This was due to the perceived risk presented by the country’s fiscal position.

The obvious question this raises, though, is: ‘What is risk?’

Different views

If you buy a South African government bond, there is some risk that there will be a default and you will take a degree of loss. But is that risk worse than the certainty of taking a loss for 30 years on Swiss bond?

At the same time, at a yield of 8.5% the South African bond is giving you a return well above inflation. If you are investing for income, there is a fair amount of certainty in that. If however, you put your money in a negative-yielding bond, the certainty is that you will get no income at all.

Similar questions can be asked about the South African stock market, particularly when it comes to companies’ dividend yields.

The general perception is that local shares are risky. The local economic environment has hurt earnings, the outlook remains uncertain and stock prices have fallen as a result.

However, when share prices fall, dividend yields go up.

At the end of 2014, the yield on the FTSE/JSE All Share Index was 3%. By the end of 2019, it had grown to 3.6%.

If you are investing in quality companies, there is also a lot more certainty in these yields than many people imagine. One significant example bears this out.

Upside-down prospects

Clicks has been one of the JSE’s most outstanding performers over the past 15 years. Over this period its share price has gone from R8.50 to R237.00.

Read: The JSE’s five top-performing shares since 2005

What is even more compelling is that the dividend it has paid out over the past 25 years has grown even faster than its share price. The company has not once decreased its dividend since 2005.

Source: Bloomberg, Marriott

With the pressure on share prices, some quality South African names are now trading on extremely attractive yields. Shoprite has a dividend yield of 2.6%, FirstRand is yielding around 5%, and British American Tobacco’s dividend yield is 6.2%.

So, what is risk? These are all companies with healthy cash flows and entrenched market positions. Their dividends are therefore largely reliable.

If that is your investment consideration, there is more certainty of good outcomes from the South African market now than there have been for some time.

“We’ve been told that there are better valuations on South African equities now, but what do you do with that as an investor?” asks Duggan Matthews, investment specialist at Marriott.

“For us, when it’s cheaper it means that yields are higher, so the outcome you can look forward to is better, regardless of price performance.”

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The current situation with first world negative long bond yields could be directly related to uncontrolled debt by these governments and the unprecedented printing of money (biggest culprit USA). Surely if government debt is piling up and there is almost no chance of correcting the balance sheet, low or negative interest rates would be the answer to survive. Only problem is the underlying economy must stay strong (Zimbabwe also tried printing money). However, the big central banks of the world are uneasy because uncontrolled debt is not sustainable hence the quit (and immense) hoarding of physical gold to at least show something positive on the balance sheet. This is amongst others why the gold price is slowly but surely moving in one direction. There is a saying “he who has the gold makes the rules”. No indication of central banks hoarding bitcoin. Bottom line: in these unprecedented inverted and illogic times in the market it is perhaps wise to invest in some physical and indestructible assets like gold and silver. There are 4000 years of data to back this approach.

Yield is King – with or without the ‘’Coronavirus”
‘’The only way to get rid of a temptation is to yield to it’’
Oscar Wilde.
I am ad nausea writing reports, trying to convince my old ex FX colleagues (some managing their client’s books on an outsourced basis), that the smart money will start flowing back into sunny SA again due to the high yield that most emerging markets offer.

Pension World Reels From ‘Financial Vandalism’ of Falling Yields
Anchalee Worrachate

‘’A once-unthinkable collapse in global bond yields is forcing pension funds to buy bonds that offer negative returns — putting the financial security of future retirees in jeopardy.
U.S. institutions managing trillions of dollars in retirement savings — including the California Public Employees’ Retirement System — have been ratcheting down return expectations. Japan’s Government Pension Investment Fund, the world’s largest, has warned that money managers risk losses across asset classes. In Europe, pension funds may be forced to cut benefits in part thanks to the decline in rates.
Investors were already taking on more credit risk to make up for dwindling income elsewhere, with some chasing less liquid markets like private debt. Now, negative yields on over a quarter of investment-grade bonds — with more monetary easing to come — are increasing the urgency for portfolio managers to find new sources of returns’’

It’s the market’s role to price risk. Are you saying the market is getting it wrong? If not, what are you saying?

Who is actually buying the negative yielding instruments?

Governments issuing and being bought by their own central banks?

If anyone else is buying those, its a trade on rates going down more, thus increasing price and locking in capital appreciation, with the intention of dumping the instrument back in the market…. Nobody else takes a guaranteed loss, just sit on the cash…

End of comments.





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