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THE OVERLOOKED SWEETSPOT FOR INVESTING
September 2012
Central bankers have forced bond yields to such artificially and historically low levels
that returns on fixed income portfolios have been disappointingly low. Further, as low
interest rates persist and coupon payments remain depressed, the sensitivity of bond
prices to interest rate changes increases. In other words, with low interest rates the
likelihood of higher interest rates—and consequently lower bond prices--in the future
increases.
During this period of disappointing bond yields, dividend paying stocks have moved into
what we consider “the sweet spot” of investing. Whereas in previous decades fixed
income securities were purchased for income, coupon payments are now such that blue
chip companies like Royal Dutch Shell and AT&T are paying far more on dividend
payments than they do on their medium term debt issuance (Exhibit A) even after taking
account of tax withheld at source.
Equities for Yield
Dividend Yield
Gross
Net
5 Yr
US Treasury
Yield pick-up
vs. Net
6.06%
4.24%
1.37%
+287bps
4.67%
3.27%
1.21%
+215bps
4.64%
3.25%
1.09%
+355bps
3.59%
2.51%
0.77%
+174bps
Exhibit A: Equities for Yield (source: Bloomberg)
The Overlooked Sweet Spot for Investing
September 2012
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So the focus at BIAS in recent years has been dividend paying stocks which have a
history of maintaining and increasing income distributions to its shareholders. Fixed
income securities should now be used only for capital preservation purposes, but
dividend paying stocks, controlled for consistency of payment, do provide an opportunity
for recovering income flow into the portfolio whilst giving potential for capital
appreciation. Moreover, an investment portfolio entirely invested in fixed income
securities presents some risk when one considers that in a rising rate environment, bond
prices will fall.
To further illustrate the attractiveness of stocks versus bonds, consider two valuation
measures that we have presented in our most recent Quarterly Market Briefing:
1. The Fed Model compares S&P 500 Index earnings yield against the US Treasury
Ten-Year bond yield.
2. Credit Suisse First Boston’s (CSFB) Global Risk Appetite (GRA) measure.
In the former (Exhibit B), when Ten-Year Treasury yields are well in excess of earnings
yields on S&P 500 Blue Chip stocks, stocks are considered over-priced relative to US
Treasures. On this basis however from 1980 to 1982 and 2011 through today, stocks
were/are under-priced. Although these anomalies can persist for some time, history has
shown that they provide rich opportunities when yield disparities are at their extremes.
Fed Model
10-Year Treasuryminus S&P500 Earnings Yield
6
Stocks Expensive
Sell
4
2
Ja
nJa 62
nJa 64
n6
Ja 6
nJa 68
nJa 70
nJa 72
nJa 74
nJa 76
n7
Ja 8
nJa 80
nJa 82
nJa 84
nJa 86
nJa 88
n9
Ja 0
nJa 92
nJa 94
nJa 96
nJa 98
nJa 00
n0
Ja 2
nJa 04
nJa 06
nJa 08
nJa 10
n12
0
-2
-4
Stocks Cheap
-6
Buy
-8
Exhibit B: The Fed Model
The Overlooked Sweet Spot for Investing
September 2012
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As to point two above, in the late 1990’s CSFB initiated a study to measure extremes of
investor sentiment. They discovered how these extremes signal turning points in stock
market performance as indicated by the S&P 500 Index (Exhibit C). Specifically,
extremely negative sentiment, as shown by a global risk appetite (GRA) score below
negative 3, was followed by strong rallies in the stock market. We see this in 2002,
2008/9, and more recently in 2011.
Risk Appetite
9
Previous Extreme Lows in Global Risk Appetite Have Been Associated
with a Major Turning Point for Equities
7
Global Risk Appetite
Euphoria = +5
5
3
1
-1
-3
-5
-7
Panic = -3
-9
1600
S&P 500
1400
1200
1000
800
In 1982 the GRA predicts
recovery in the S&P 500
600
In 2002 the GRA
predicts recovery in
the S&P 500
400
200
0
Jan-81
Jan-86
Source: Credit Suisse First Boston
Jan-91
Jan-96
Jan-01
In 2008 Bottom the GRA
predicts recovery in
Advance
Jan-06
Jan-11
EXHIBIT C: CSFB’s Global Risk Appetite and the S&P 500 Index
At present GRA hovers slightly above the panic stage which tells us that stocks are
reasonably valued (because sentiment remains only ‘somewhat’ negative) and that any
deterioration in sentiment near term could result in a strong upward movement in the
broad stock indices thereafter. Many stocks in the S&P 500 Index do not pay dividends
and those that do tend to fare better in good and bad times. All of this leads us at BIAS to
believe that the place to be during times of negative GRA is in stocks that have a
discipline of regularly returning capital to investors in the form of dividends. This is
reinforced by a review of the performance of our Dividend Income Strategy for various
periods up to June 30, 2012. The outperformance relative to the S&P Global 1200 Index
has been substantial. Indeed in assessing BIAS’ own dividend income strategy,
performance well exceeded that of the broad stock indices as indicated below (Exhibit D)
The Overlooked Sweet Spot for Investing
September 2012
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Performance
Performance*
YTD
1-Year
31-Aug-12
Dividend Strategy
S&P Global 1200 Index
2 - Years
3 -Years
5 -Years
Cumulative
Cumulative
Cumulative
40.76%
24.74%
69.20%
27.96%
45.70%
-5.10%
12.92% 17.41%
10.31% 8.95%
EXHIBIT D: BIAS Global Dividend Income Strategy vs. S&P Global 1200
(Performance shown is current dividend income strategy back valued 5 years, rebalanced annually. Past performance is
no guarantee of future results).
In addition to the greater potential return benefits, dividend income strategies have
provided a lower level of risk than the broad stock indices as shown in Exhibit E. All this
argues for a higher allocation to equities in investment portfolios subject to equities
exposure being focused on stocks that have consistently maintained or increased
dividends over an extended period of time.
Risk vs. Return--Annualised
Last 10 Years--June 2002 - June 2012
8.0%
7.3%
7.0%
6.0%
S&P Dividend
Aristocrats
Return
5.0%
4.0%
S&P Global 1200
3.0%
2.6%
2.5%
2.0%
S&P 500
1.0%
0.0%
14.0%
14.5%
15.0%
15.5%
16.0%
16.5%
17.0%
17.5%
18.0%
Risk
EXHIBIT E: Risk Return Comparisons of Stock Indices (source: BIAS, Bloomberg, Standard
& Poors)
The Overlooked Sweet Spot for Investing
September 2012
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Disclaimer:
This release contains “forward-looking statements” which are based on the firm’s current
expectations and beliefs concerning future developments and their potential effects on the
firm and the fund. There can be no assurance that actual developments will be those
anticipated by the firm. Actual results may differ materially from those projected as a
result of significant risks and uncertainties, changes in interest rates, effect of the
performance of financial markets, fair values of investments, as well as others that may
cause actual results to differ materially from projected outcomes. The firm undertakes no
obligation to publicly update any forward-looking statements, except as may be required
by law. Potential investors are advised to seek professional assistance prior to making
any investment. The BIAS Global Dividend Income Fund is not eligible for US
investors. Further information, disclaimers and policy notes may be found on the firm’s
website www.bias.bm and as disclosed in the firm’s ADV Part II also on the firm’s
website.
BERMUDA
CAYMAN
Bermuda Investment Advisory Services Limited
BIAS (Cayman) Limited
st
1 Floor Wessex House
P.O. Box 30862
45 Reid Street
Grand Cayman KY1-1204
Hamilton, HM 12
Cayman Islands
Bermuda
Tel: (441) 292-4292
Tel: (345) 943-0003
Fax: (441) 292-7292
Fax: (345) 943-0004
The Overlooked Sweet Spot for Investing
September 2012
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