Shifting from yield to growth

We believe this is a critical moment in markets as the bond market (which is 10 times the size of stock market) looks like it is about to break down. If the bond market weakens, we think we will see a spread of uncertainty into the stock market over the short term - in the end, the stock market should go higher after a correction. Over the last several years, since interest rates were pushed down from the financial crisis, investors were forced into bond “proxies” to acheive the yield they once received on a bond. As these bond proxies received so much capital inflow, they began to inflate in price, eventually becoming overpriced, and consequently, producing a lower pay. We think these are dangerous positions to hold large amounts of capital.

 

This is the long term chart showing interest rates dropping to almost zero in 2008, which has caused the frenzy toward income producing investments.

 (Source: Bloomberg)

 

This is the US 30 year bond, tracked by the interest rate investors would receive holding it, and it has moved from 2.5% yield to over 3%, meaning bond prices have fallen.

 (Source: Bloomberg) 

 

As interest rates dropped, investments with high dividends (yield) bond “proxies” rose incredibly. A good example of this is Enbridge, as the stock price has climbed significantly since 2008. 

 (Source: Bloomberg)

 

Yields are down considerably from a normalized yield environment. If we normalized yields, we think there could be a similar decline in stock prices. As illustrated in the chart below, we can see an interest rate environment that did not have 0% interest rates, and these companies (Enbridge, Alta Gas, Keyera Corp, TLT: 20+ Year Treasury Bond ETF) all had far higher yields. We see this as a major risk.

 (Source: Bloomberg)

 

The primary premise is that historically safer portfolio allocations in bonds and utility style investments is now far more dangerous if bonds correct as we expect. Instincts must change and investors must move away from those investments to find safety. We can see an upcoming market shift from yield to growth.