What is happening?
Weakening employment data here in the U.S., battles between growth and austerity policy in Europe, and concern over China’s ability to sustain high growth all have investors on edge.
After the best start since 1998 for equity markets in the first quarter of 2012, stocks have recently retreated back to where they were at the start of the year. On Monday, June 6, 2011, the Standard & Poor’s 500 (S&P 500) closed at 1286.17, and the Dow Jones Industrial Average (DJIA) was at 12089.96. Remarkably, on June 1, 2012, the S&P 500 closed at 1278.04, while the DJIA finished at 12118.57. However, the silver lining (again this year) is that bond prices have increased recently after being left behind in the first three months and yields have fallen even more, benefitting balanced and fixed-income portfolios. In fact, as we speak, 10-year U.S. Treasuries are yielding only 1.5%.
Our strategy and outlook during a more difficult period
Prior to the correction, we reduced our equity exposures by almost 8% in the Balanced Fund, taking advantage of the appreciation at the start of the year. In addition, we increased our allocation to managers within the Equity Fund who specifically utilize hedging strategies. Finally, we continue to look for higher-yielding substitutes for the lowest bond yields in the last 50 years, where prudent and appropriate.
While these steps can somewhat cushion your retirement assets against the possibility of another 2010 or 2011, we don’t want to lose track of longer-term opportunities. Earnings, especially in the U.S., have been relatively strong and housing shows signs of stabilizing. Commodity prices have fallen, along with inflationary expectations. This leaves more room for monetary authorities to continue their easing policies. Although we have taken some money off the table in equities in balanced funds, we do favor stocks over bonds in the longer term.
What is our longer-term view?
Bond Yield versus Dividend Yield versus Inflation Rate
Source: Bloomberg and CLSA
The table above (first column) shows 10-year government yields of North American, European, and Asian developed nations. Next, current dividend yields on equities are shown, followed by a calculation of the ration of equity dividend yields to bond yields. We have shown this ratio for October 2011 and June 2012, to illustrate the improvement. Finally, the current inflation rate is compared to the 10-year government bond yield to illustrate whether your return from lending money to selected governments would be a good idea, or whether your returns could be eroded by inflation. Equity dividend yields (an important part of total returns for equities) have become very attractive relative to bond yields!
Our strategic orientation is to survive these more difficult periods by preserving your retirement assets in the short term, and also to act on your behalf to position the funds for longer-term benefit. Our utmost concern is to prudently keep aware of both the risks and opportunities.
We will continue to keep you informed.