Market Commentary – May 2020
By Neil Worsley, Investment Strategist
Following on from last month’s commentary, I have been looking again at the relationship of bonds and equities, especially as many investors still require that a portion of their portfolios be invested in fixed income securities.
For many years now, the rule of thumb for balanced and income portfolios was a 70%/30% equity Vs bond split of assets especially, prior to the last 10 years, when government bonds yielded more than shares and with the added benefit that they offered a safe haven in times of crisis and security of yield. That has now changed of course with many government bonds around the world offering negative returns, despite the tsunami of issuance which is occurring, and the high levels of debt being taken on by many countries around the world. Many companies would be considered a high-risk investment with these dynamics. In addition, investors are being asked to take a negative return over a portion of their portfolios for including these assets, yet still require above average income. So, what to do as an investor?
I have been looking at the performance and behaviour of different shares in the present crisis to see whether there might be alternatives to the bond investments which investors require. I have taken a selection, of what I consider to be very high-quality companies, based on factors such as their industry, debt levels, security of earnings, position in their sector, financial health and track records. I have highlighted 7 individual stocks, this could have been more and is by no means exclusive, on a global basis which fit these categories and tracked their behaviour and performances over the past 13 years to include the last financial crisis. The stocks I have analysed are Nestle, Novartis, Disney, Google, Unilever, Microsoft and L’Oréal. These stocks each have a global spread and so effectively reduce currency risk as well as covering a diverse range of industries and fitting the criteria outlined earlier.
I initially looked at the share price performances over the shorter term to include the present equity market falls of the past few weeks. As can be seen from the table below, the equally weighted basket of stocks compares very favourably with the bond performances of 3 of the major blocs, although US Treasuries have performed notably better over the very short term as interest rates here have seen a more dramatic turnaround. However, even on a one year view, the basket has performed creditably and certainly hugely outperformed the FT All Share Index.
If we take the last financial crisis of 2007 to 2009 which in itself was fairly brutal and has economic parallels with today’s events, the performances are -
The evidence on the above is not quite so clear cut, however, the basket continues to strongly outperform its equity counterparts and for most investors would still have provided a positive and satisfactory performance outcome over the period.
It is also worth mentioning that interest rates and bond yields also began the 2007/09 financial crisis at much higher levels and so the dramatic falls in interest rates had a much bigger impact on government bond yields and therefore, the appreciation of bond prices.
My conclusions from the analysis is that over very short term periods, government bonds will outperform my diverse blue chip basket of stocks but as time goes on, the basket begins to assert its superior performance. Apart from government bonds, other fixed instrument instruments fair little better than my basket over these short term crisis periods (and often much worse) as investors fret over default risk, so lower grade bonds are not such a reliable alternative in these negative conditions. In my view, an investment in government bonds is now fraught with risk and for that you will receive no absolute return. On the other hand, investors who are prepared to take on short term negative, but acceptable returns would do well to incorporate some form of defensive equity content rather than either a government or other fixed interest component. In addition, this basket of stocks yields significantly more than government or high grade bonds, increases the dividend each year, has a much better debt profile than most governments, has global diversity providing a ‘global currency’ and provides a much better return to investors than bonds over most time frames. The negatives are that many of these stocks ‘look’ expensive compared to other equities and will almost certainly under-perform their peers in any economic recovery, but history suggests that they will continue to outperform their bond counterparts. In a balanced/income portfolio however, they look like a worthy addition, especially to complement an existing equity list and where investors do not mind reducing their fixed income exposure.
Out of interest, 2 of the 7 stocks which I looked at gave a positive return, in sterling, in every single year covered from 2007 to the present. For those wanting further information, as I have lots of data over multiple years, please let me know. For interest, I have included the returns since the beginning of 2007 (the previous financial crisis) to date in the chart below.
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