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Analysts' IntelligenceFixed Interest & Bonds

How big players are navigating the difficult markets

22 Jun 2022 1 month(s) ago

Strategies of diversification, especially between shares and bonds, that usually work are coming under pressure. Here is what analysts' thinking is.

Large professional investors try to diversify their capital in the belief that if one type of investment does poorly, others will do well. The most common such diversification is between shares and bonds. The belief is that if shares do poorly, bonds will tend to do well. It is a belief that has usually been proven right over the years.

In the US the principle is not holding true: both shares and bonds are doing badly. Also, because interest rates are so low, cash is not much of a safe haven either. It is a difficult environment in which finding good returns, or even a sound defensive strategy, is unusually difficult, as UBS notes in saying asset allocators are being hit with a 'double whammy'

“Year to date returns from bonds are currently the worst seen in decades. At the same time equities are facing their own challenges, with stocks in most markets showing negative returns in 2022. The sharp sell off in bonds over the last six months has meant that bond yields are competitive against dividend yields again.”

Australia's long bonds interest rate (10 year Treasury bills), has soared, increasing four-fold since last August:

UBS says long duration stocks (high growth) are likely to be more positive:

“Long bond yields usually stop rising once the RBA begins tightening. This means duration equities typically underperform leading into the first rate hike, after which the headwinds caused by rising bond yields begin to recede. In the case of REITs, this allows the sector's inflation hedge characteristics to begin to shine. For technology stocks, the stabilisation of long bond yields means that the growth potential of their earnings switches back to being a key positive.”

UBS says valuations for technology shares now sit 30% to 50% below where they were just six months ago. Through this same period REITs have also de-rated noticeably.

“We believe that 'Value trap' concerns seem misplaced in these instances given REITs' earnings stability, and the pricing power which Tech companies enjoy.”

UBS picks in the REIT, Infrastructure and Technology sectors companies hit hard by what has happened in the bond market and which may represent value: Mirvac, Stockland, GPT Group, Xero, Pro Medicus and Wisetech. It says they have fallen markedly and are looking inexpensive versus their 5 year histories.

UBS says in a world of rising rates, Australia still one of the better equity markets to be in.

“Rising bond yields are less of a threat to Aussie equity market returns than is the case for many other markets. This is a product of 1) the Australian markets disproportionate weighting towards pro-cyclical resource sectors (approximately 25% of index), and 2) the additional value skew provided by banks (approximately 30% of index). We maintain our year end target for the S&P/ASX 200 index of 7700, which implies 6% upside from current levels.”


Reader note: This is general reporting only and should not be considered in any way to be investment or tax advice. It does not take into consideration the investment objectives, financial situation or particular needs of any particular investor. For more information please read our disclosure statement.

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