The Search for Yield Is Over

Markets moved higher overnight thanks to strong gains in oil and other commodities.

West Texas crude jumped nearly 3%; copper was up 1.5%; and gold put on around 0.2%.

Apparent cooperation between Saudi Arabia and Russia was behind the rally in oil. And if you want an excuse as to why other commodities did well, let’s use China’s return from a week-long holiday.

That was the justification given for the rise in the iron ore price. From The Australian:

The iron ore price has jumped back above budget estimates as traders return to their desks after a week-long public holiday in China.

Iron ore rose 2.6 per cent to $US55.80 a tonne overnight, according to The Steel Index, from $US54.40 in the previous session.

It makes perfect sense, doesn’t it?

China’s been off for a week. So of course traders and going to ‘return to their desks’ and buy iron ore. But if it is so obvious, where were the buyers taking advantage of this last week?

This is the effect of hindsight bias in action. That is, we can easily construct a narrative around events after the fact. But before the fact, we have no idea what is going to happen.

If iron ore fell, the reasoning would be the complete opposite. That is, ‘iron ore prices fell as traders return to their desks after a week-long public holiday’.

Simple. Case closed.

What’s not so simple is employing foresight. That’s because we really have no idea why the price of something moves the way it does. It is only in hindsight that the reason for the move becomes obvious.

For example, what’s happening in the Aussie bond market?

It might seem like a weird question to ask. But bond prices have a major impact on the equity market, especially in Australia, where the ‘search for yield’ has been the driving force behind the market over the past few years.

The question is this: Are bond prices topping out after a massive bull run?

Have a look at the chart below. It shows the S&P/ASX Australian bond fund, which tracks an index of Australian government bonds of varying maturities.

S&P/ASX Australian bond fund

Source: Optuma
[Click to enlarge]

The big rally during 2014 and early 2015 reflected the deflationary threat from falling commodity prices, notably iron ore, coal and oil. Remember, as bond prices rise, yields fall. Falling yields represent a low growth or deflationary environment. Rising yields (falling prices) represent a higher growth or inflationary environment.

After peaking in March 2015, prices fell sharply and then went sideways, before moving higher again in 2016. This year’s rally, however, coincided with rising commodity prices. It was driven primarily by the RBA’s unnecessary rate cuts in May and August of this year.

Following the August rate cut, the market rallied briefly, but it turned down just as it breached the 2015 high. In fact, it turned down sharply as expectations about the direction of global interest rates changed markedly.

The trend (as reflected by the red and blue moving average lines) is now about to turn down, too. My hazy foresight guess is that prices will continue falling over the next few months, until they find support roughly around the $26 mark (you might have to enlarge the chart to see).

This has major implications for some sectors of the equity market.

The RBA’s historic interest rate cuts resulted in billions of dollars shifting out of cash and fixed interest, with the capital moving into ‘bond proxies’, like property trusts, banks and utilities.

Those sectors have performed very well, thanks to falling yields. But, recently, some yield play stocks have come under heavy selling pressure.

Have a look at the listed property sector, as represented by the Vanguard Australian property securities index.

Vanguard Australian property securities index

Source: Optuma
[Click to enlarge]

It rallied strongly into the start of 2015, before correcting for the rest of the year. It took off again at the start of 2016 and made significant new highs. But the recent bond market correction has taken its toll.

As you can see, prices fell sharply during August and September. A brief rally followed, but the selling quickly resumed and the sector just broke down to fresh lows.

The experience is similar for nearly all other ‘yield play’ stocks. That is, the market appears to be in the process of repricing these stocks as equities, not as bonds.

The big foresight question is: How much longer will this trend play out? Is this the start of a major shift from deflation and disinflation to an inflationary environment? Or is it just an adjustment from crazy low yields as global monetary policy shifts to a slightly less stupid stance?

Or, could it be that bond markets are beginning to price in the move from monetary to fiscal policy as the major tool for economic management in the years ahead? If this is the case, a big increase in the supply of government paper is on its way.

My guess is that it is the latter. But this will only become an explanation in hindsight. Right now, the most popular narrative is that this is just a backup in yields, due to central banks slowly withdrawing QE and, in the case of the Fed, raising rates.

Whatever the reason, though, if you’re overexposed to popular yield plays like property trusts, you may want to reconsider your exposure.


Greg Canavan,
For Markets and Money

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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