Last May, prior to the “Taper Tantrum” that forced investors for the first time in years to contemplate an investment landscape with higher yields, bond proxies were all the rage. High yielding sectors like Reits, Utilities and Telecoms were trading at or near all time highs in lock step with the broad indices. Since then, the SPX has made new highs and yet some of the more defensive higher yielders have been left in the dust. They have underperformed despite one very important fact – bond yields don’t appear to be going anywhere fast in spite of the Fed’s recent insistence of a gradual Taper of QE. At one point, the yield on the 10 year Treasury doubled off of what many would argue was a very artificial level last May. But bonds are not being sold as most predicted in the face of what was thought to be an improving economic backdrop both here and abroad.
Early this year, global investors were once again reminded of the very few options they have when looking for “safe haven” trades. U.S. Treasuries obviously remain high on the list, which is one reason for the rates not busting through important psychological levels on the upside.
So whats the trade? On Jan 30th in this space (MorningWord 1/30/14: No Mr. Bond, I Expect You To Die) I laid out the potential for a bond move lower which was also predicated on the fact that expressing that view through the options market was a relatively cheap way to do so. But the relative cheapness of implied vol in TLT may be for a good reason – maybe bonds have found a bit of an equilibrium as the Fed pulls back but the marketplace has found natural buyers to replace a fairly unnatural one in what is amounting to a more volatile year for economic growth in 2014. So I am not sure there is a whole heck of a lot of edge trading bonds from a pure directional sentiment right here as the likelihood of the Fed reversing course and sending yields back to the lows isn’t great, while the recent economic data does not suggest the global economy will see a meaningful pick up any time soon.
Maybe it is time to reconsider some of the fairly defensive “bond proxies” whose values have declined dramatically since last May. Some of their yields have gone up – perhaps these are the attractive “safe haven with a kicker” trade for 2014?
Utilities, as measured by the XLU, have already started to run, up about 5% on the year, and only down about 3.5% from the 5 year highs made last May. Fundamentally, many of the utilities are also quite rich vs. their historical P/E multiples, with poor growth prospects given the changing nature of energy supply in the U.S.
The single stock front looks more interesting. Telecom stocks like T and VZ that sport dividend yields of 5.5% and 4.5% respectively are down btwn 13 and 14% from their 10 year highs made last May, with decent P/E multiples vs. growth expectations, and quite cheap vs. the rest of the market. REITs, as measured by IYR, are also up on the year, but sit 13% below last spring’s highs.
Bond king Jeff Gundlach was on CNBC earlier this week laying out the bull case for Treasuries for 2014. If he’s right, some of the left-behind high yielders could be the real winners this year. We’ll be on the lookout for opportunities.