The sell-off in yield stocks that plagued the sharemarket in October is set to ease, despite ongoing volatility as interest rates remain forefront of investors minds, strategists say.
Bond yields globally have been rising, and the corresponding sell off in bond proxy stocks intensified in October, sending the S&P;/ASX 200 Index down 2.5 per cent for the month.
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Rising bond yield causing ASX to underperform
As the ASX 200 is the global poster boy for traders to pick up dividend income, the ASX underperforms when bond yields rise. (This video was produced in commercial partnership between Fairfax Media and IG Markets)
Just two sectors have ended October higher, with materials the standout, up 1.4 per cent due in large part to stellar runs by heavyweights Whitehaven Coal and Fortescue Metals Group amid resurgent commodity prices. The coal and iron ore producers have run up 26.5 per cent and 13 per cent respectively. The financials index is marginally higher, up 0.2 per cent.
The rest of the index closed deep in the red, with the worst hit sectors real estate, down 8.9 per cent, and health, down 8.3 per cent.
Investors also moved swiftly to savage companies that have provided disappointing earnings updates, including Healthscope, Bega Cheese and Estia Health.
"A lot of the dip in the last month or so has been in the very high-growth, or perceived to be high-growth companies," Credit Suisse equity strategist Hasan Tevfik said.
Mr Tevfik said the market's moves are linked to the fact it is approaching two key turning points, the so-dubbed "bondcano", where bond yields are marching higher, and the end of the profits recession, where earnings are beginning to move into positive territory.
Volatile period
The Australian sharemarket has underperformed global peers during the bond yield rise of the past few months because it is more top heavy in infrastructure, REITs and other low growth, high dividend yield stocks, he said.
"Given the sharp rise in bond yields, it is fair to expect a bit of a pullback [in the bond sell-off]," Mr Tevfik said.
"In the near term the transition is going to certainly be a volatile period for markets, but this is consistent with what we've seen in the past with turning points," he said.
But he said Credit Suisse remains overweight commodities, and underweight bond proxies, and prefers lower valued companies such as Myer over highly valued companies such as Healthscope.
While yield stocks have been summarily sold as inflation data around the globe ticks up – including local inflation which last week reported a headline read of 1.3 per cent year-on-year – State Street Global Advisors Asia Pacific head of quantitative strategy Olivia Engel said it was too early to dump the yield strategy.
"I think [the sell-off] has been a bit of an overreaction," she said.
"The whole world is entering this inflection point in regards to monetary policy, but I think the market's gotten ahead of itself."
Global growth remains slow, earnings growth remains anaemic and companies still pay out a high proportion of their earnings in dividends, keeping a lid on capex. These factors will serve to keep the demand for yield high, she said.
"The market is probably fatigued by the whole theme of low interest rates and growth, investors want to be optimistic and that's natural," she said.
Short-term shift
"I don't think the sell off will last too long. These businesses are still quite good. I think it's just a market sentiment shift that will be short-term."
Indeed, the sell-off has made bond proxy, or interest rate sensitive stocks more attractive which may lead to a reversal in the recent trend, Ms Engel said.
Deutsche Bank strategist Tim Baker said it was too early to call the end to the yield play, and it was "appropriate" for portfolios to still hold a number of these stocks.
He said yield stocks had been "harshly dealt with" in Australia, underperforming by 15 per cent over the past quarter compared with a relatively mild 40 basis point rise in bond yields.
"We don't see bond yields rising much, removing a catalyst for more underperformance," he said.
"Yield stocks could even trade a little rich again, given their ongoing scarcity value in offering a decent real yield," Mr Baker said.
Deutsche Bank's picks include Stockland, Telstra, Sydney Airport and APA.