In simple terms, this means investors in five year German bonds are happy to pay more than they will get back, if they hold the debt to maturity. Granted, they are paying less than if they were to put that money on deposit at the ECB, but it still begs the question why?
And, more importantly, are there not better places to put one’s money? Especially when one takes account of how much of the market is now in that position. According to data compiled by Bloomberg, thirty-one of the 54 securities in the Bloomberg Germany Sovereign Bond Index have negative yields.
“That equates to about $711bn of securities, out of a total of about $2trn of negative-yielding assets in the Bloomberg Global Developed Sovereign Bond Index,” the wire service said.
The first part of the answer could lie with those investors, particularly from outside Europe, that are more concerned with return of capital than return on capital, and who still see German paper as one of the safer bets. Of course that is unlikely to be the major driver, but it will have provided some of the impetus.
The second possible answer involves equities. As my colleague Alex Sebastian, discussed in yesterday’s analysis, markets are most certainly climbing a wall of worries and are beginning to reach heights that would make even the most skilled climber at least a little vertiginous. The problem with this argument, however, is that bond markets have moved a lot more than equities, largely on the back of the massive liquidity programmes that have been in place since 2008.
The QE effect
A more likely answer, for this negativity comes from AXA’ Wealth’s s Chris Iggo. Talking in the FT, he said: “QE mania still dominates bond markets”. The implication of this, the FT points out, is that, although bond holders are now on the receiving end of a negative yield, there is a view that, despite this, because the ECB is going to come into the market as a significant buyer of bonds, holders will be able to sell those bonds at a higher price than they bought them, before they need to worry about the yield.
There is no doubt that the ECB’s bond buying programme is going to have an impact on the market. If one takes the US and the UK as an example, all asset classes are likely to benefit. But, will it be the case this time that bonds benefit the most?
Is a dividend yield rerating on the cards?
LGIM global equity strategist, Lars Kreckel argued in a note on Thursday that to date it is possible to argue that equities have not benefitted from QE to the same extent as bonds have: “Dividend yields have remained remarkably stable at a time when bond yields have been pulled lower and lower by the gravitational force of easy monetary policy.
He added: “Bund and European corporate bond yields are around three standard deviations below their 15 year averages. In other words, equities may have priced in the improved outlook for the economy and earnings, but they have not priced in that bond yields will remain at current extreme levels for longer.
Should such a rerating of dividend yields occur, however, this would imply significant further upside for stock prices.
While quick to point out that this is not LGIM’s base case, Kreckel points to four signs that persistently low bond yields are beginning to spill over somewhat into equities.
The first is the re-rating of the real estate sector in the second half of 2014. “This trend has accelerated since the start of 2015 as bond yields have fallen to new lows in anticipation of the ECB’s quantitative easing program,” he said. Adding: “There is also plenty of anecdotal evidence that the investor mix in the real estate sector is increasingly shifting towards more macro and multi-asset investors who are attracted by its yield rather than its capital appreciation potential.”
The second such sign, for Kreckel is that a similar scenario has played out across other bond proxy sectors, resulting in a convergence of yields across equity sectors.
The third sign is the sharp acceleration of inflows into income funds, and the fourth is the increasing importance being placed by investors on dividends.
“Equities may have re-rated against earnings, but not against dividends. Instead, share prices have risen roughly in line with dividends. Looking at this from a different perspective, would it not have been strange had equities gone up less than dividends? That would have implied that dividend yields had risen in a world where all other yields have been falling sharply,” he said.
There is by no means any guarantee that significant equity re-ratings are likely, but it is no less odd an event to imagine than much of European debt trading at negative yields.