Bond Refugees
Citi Research has observed that companies around the world are sacrificing investment and research expenditure to increase distributions to shareholders.
Giving in to the yield chasing fad is a deeply concerning trend for long-term value investors.
Since 2013, buybacks and dividends have increased faster than capital expenditure across all major regions and sectors. Citi considers that this dynamic is largely being driven by “bond refugees” entering the equity markets.
Aggressive purchases of government bonds by central banks, without a commensurate increase in supply, has resulted in a shortage of products for income-hungry investors. As bond prices have increased and yields have fallen, these investors have had to look elsewhere to satisfy their income requirements – and it seems that dividends of companies are considered a reasonable substitute.
In Europe alone, the bond purchasing program will completely absorb all new sovereign bond issues for the year, and the excess will go to reducing existing bond supply and may even flow into equity purchases.
This is not a sustainable practice for long-term investing, and creates a false sense of security through buoyant share prices. Since 2013 we have been discussing the emergence, development and ultimate demise of the yield chasing fad.
You can follow the trend, including company management capitulation, with some of our key articles here:
October 2013: http://rogermontgomery.com/on-the-chase-for-yield/
April 2014: http://rogermontgomery.com/has-the-search-for-yield-run-out-of-steam/
October 2014: http://rogermontgomery.com/long-weekend-reading-to-yield-or-not-to-yield/
March 2015: http://rogermontgomery.com/theres-no-such-thing-as-a-free-lunch/
And as Andrew Macken summarised in this recent blog titled “The fallacy of dividend yield investing”, capital losses can (and will) quickly wipe out the dividend income received from stocks. The risk of capital losses increases the more share prices rise above intrinsic value, and it seems that bond refugees are influencing management of listed companies to sacrifice capital reinvestment for short-term distributions and share price support.
In short, when a company with the ability to retain profits at high rates of return, elects to pay those retained earnings out, the price might rise, but the intrinsic value comes down. And as bond refugees enter the party en masse, Montgomery Investment Management dances ever closer to the door.
Ben MacNevin is an Analyst with Montgomery Investment Management. To invest with Montgomery, find out more.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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