Is Another Yield Crunch Coming?

Back at the end of 2018, I indicated that as a result of a weaker-than-expected economy both the RBA and bond markets were poised to see a significant drop in interest rates and with the Australian ten-year bond yield reaching under 1% this would create a “yield crunch”.

This occurs when there is a huge influx of investment into infrastructure and property trusts because their higher yields become even more attractive when compared to the paltry returns in Government bonds. As a result, in line with the move lower in bond yields, the yields on these assets drop as well as the underlying prices of those assets are driven to new heights.

Over 2019 we witnessed gains of 39% in Transurban, 34% in Sydney Airports and in some property trusts that I highlighted like Charter Hall Long Wale gained 42% and Centuria Metro REIT enjoyed a 36% move. Big price gains, but the yields on some of these assets still range in the 4% to as high as near 6% despite the rise in the underlying share price.

Given bond yields have moved lower again (with the US yield curve inverting) as I discussed last week, will we see these high yield defensive stocks enjoy another major rally? After all as I write this, the Australian 10-year bond is yielding under 1% again and the three-year bond is returning just 60 basis points. How attractive do those other yields look in comparison!

I therefore believe that we will be embarking on another leg higher in many (not all) high yielding infrastructure and property trusts. The yield crunch thematic moves in waves and stages, like or re-ratings and the majority of the 2019 adjustment came mostly in the first half of the year. Many stocks like Transurban (TCL) below, in fact made their peak back July of last year and have effectively been consolidating since. An attempt in the past week to register new record highs can be seen and I believe it’s only a matter of time before it does. I certainly believe the dip in the past two days to $15.50 represents good buying (representing a trailing yield of 3.90% – 330 bp more than a three year Government bond).

The question comes what yield should stocks like TCL trade on? Now back in early 2019 when TCL was yielding 4.56%, I suggested 3% which translated into a 52% rise in the underlying share price. I still think 3% is appropriate (and even lower considering Goodman Group is 2%). But back then TCL was paying out 56.65c in dividends which has now increased to 61c. This means the new 3% yield target jumps from $18.85 to $20.33 or the equivalent of another 30% gain.

I think over 2020 if central banks are unable to lift interest rates because of constant fear that it will stifle a fragile global economy, then the yield crunch will continue. From the above we can still see that there is still plenty of meat still left on the bone in this trade. Slowly but surely yields over time will be crunched, the longer interest rates stay low. The prices reached by some of these assets will be “unimaginable” today. But then again 12 months ago a 40% rise in TCL was also laughed at.

About Greg Tolpigin

Greg Tolpigin has over 20 years of experience as a proprietary trader and high-level strategist for the major investment banks including Citigroup, Bankers Trust and Macquarie Bank.

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