Eq: Large Cap
High yield stocks have been wounded during the pandemic. The 100 worst performing S&P 500 stocks since the pandemic began have returned minus 39% and yield an average of 3.07%; the top 100 have returned over 35% and yield just 0.85%. However, now might be the time to buy in as there are some exceptional values. The core idea is that many of these wounded names are going to be bid up over the next several months as yield-starved investors try to find some income.
FINSUM: Right now it is very important to be selective about dividend stocks, as their returns are all over the map. For example, the Vanguard Dividend Appreciation ETF (VIG) has returned 4% this year, while the iShares Select Dividend ETF has returned minus 18%! The reason why is that the latter was weighted towards utilities and financials, which have suffered. Be careful what you choose!
Asset managers, other industry participants, and others on the left have been outraged over the last several weeks about a new DOL proposal that would essentially bar ESG investments from being included in 401(k)s. Multiple large asset managers, including BlackRock and T. Rowe Price have issued statements asserting how out of touch the new DOL policy would be with current wealth management trends. The general attitude of asset managers is that the DOL is trying to solve a problem that doesn’t exist. According to T. Rowe Price, “There is no factual support for the proposition that ESG is being misused currently … Accordingly, the proposed rule’s efforts to impose new requirements on fiduciaries’ consideration of ESG is not necessary”.
FINSUM: We understand the concern about making sure 401ks put economics first, but there just does not seem to be enough evidence of misbehavior to warrant this kind of restrictive policy. Furthermore, ESG funds have been outperforming conventional ones since the start of the pandemic!
Anyone who has been looking at the bond markets is likely to be shocked at the recent moves in the space. Many “high yield” bonds (it is now necessary to use quotes) are yielding what very high quality investment grade bonds were just months ago. A recent sale saw $1 bn of new issuance for a BB+ company at a 3% yield. The huge move downward in bond yields is the result of the Fed’s unprecedented stimulus action, and in particular, their mandate to backstop corporate bonds.
FINSUM: The Fed’s actions have been so warping that they have called into question the very definition of a high yield bond. If every bond is backed by the Fed, then it makes perfect sense that their yields would equalize. In this way the market’s reaction is entirely predictable.
Junk bonds have been on a tear lately. July was the best month for the asset class in nearly nine years, with overall returns near 5%. The average junk bond yield fell from 6.85% to 5.46% over the course of the month on the back on continued monetary and fiscal stimulus. The market has risen so much that many are questioning if they have already missed the opportunity. To this question, one high yield fund manager says “I don’t think so . . . Governments across the world want to make sure credit is working properly”.
FINSUM: As long as sovereign yields stay super low and the Fed and government keep the life lines open, it is easy to imagine yields will keep falling for junk.
The market is split over dividend stocks. On the one hand, about half the market thinks the huge wave of dividend cuts are over and that most of the damage has been done. One the other, many worry that not all the deleterious effects of COVID have manifested themselves on corporate behavior and that further cuts may still be in the works. The overall picture seems to be one where caution is due given the big jump in valuations and the continued possibility of further cuts. For instance, bank and credit card companies look likely to cut further as high unemployment leads to worsening credit quality and more delinquency. Wells Fargo just announced a dividend cut, for instance.
FINSUM: Our thinking here is to be careful. Even if the economy does not have another lockdown, the full effects of this recession may take a little time to fully show themselves in dividend cuts.
While some are saying that we are in “TINA” mode with equities (i.e. there is no alternative), high yield bonds have been seeing a big influx of demand. Because dividends are drying up in the stock market, high yield bonds are becoming increasingly attractive, and Bank of America thinks they are going to do well. They point out that yields in some bonds are much higher than similar yields on equities in the same sector and they expect spreads to tighten in the coming quarter. “While the easy money was last quarter, we still see many tailwinds to nudge high-yield spreads tighter in Q3...Markets should be treated to plenty of positive data surprises now that economies are exiting their lockdown hibernation…an essential ingredient for leveraged credit to perform.”
FINSUM: This seems like a reasonable call, but we think the positive data surprises might be a stretch. That said, yield-hungry investors will likely keep the high-yield space humming along.