2 Stocks for a Market Where Treasury Yields that Can Still Move Even Lower
Over the last decade or so, one of the most frequently heard refrains amongst the investment community has been "How much lower can Treasury yields go?". The answer, we have repeatedly found out, is "A lot". It looks like that will be still the case for a while longer, which leaves many searching for yield. When the 10-Year T-Note returns around 1.3% and even lending the government your money for 30-Years gets you under 2%, even the most conservative investors start to look elsewhere to juice returns.
One of the most popular areas for that, even amongst those who otherwise shun the sector, is energy. In the past, the problem has been that yield there has had a price. The sector had, until this year, been a frequent disappointment, and most long-term investments there have either lost capital value or, at best, underperformed the market. If you are retired, buying specifically for yield, and only concerned with regular income that isn't too much of a problem as long as the cash keeps coming in. The pandemic and the subsequent collapse in oil, however, made even that far from certain.
Two of the largest, non-US integrated multinational firms, Royal Dutch Shell (RDS/A: RDS/B) and BP (BP), cut their dividends massively last year. BP halved theirs, while Shell went even further and chopped their quarterly payout from $0.94 to $0.32. MLPs and other pass-through type entities, whose payouts are more directly a function of profits, cut their returns to shareholders too. The big two U.S. integrated firms, on the other hand, Exxon Mobil (XOM) and Chevron (CVX), steadfastly refused to cut dividends. That was admirable in some ways, and certainly beneficial to those who hung onto their stock through that collapse. Those that did are now benefitting from the recovery in prices and the cash flow has remained constant.
If you aren't one of those people, however, and are now looking for yield, RDS (either A or B: the difference is that A shares have voting rights while B do not) and BP are better bets.
Before we get to why those particular stocks, though, let's start with why you might want to lock in some yield now, even with rates so low.
First, you should question what you mean by "low" when it comes to interest rates. 1.3% is a lousy return on the 10-Year for individuals like you and me, but for institutions that are being handed billions of dollars by the Fed at essentially zero interest, a "risk free" 1.3% looks pretty good. That is why, as we have found out in Japan over the last 20 years or so and more recently in parts of Europe, rates can go a lot lower than that, and even negative if the times make return of capital more important than return on capital. Those low rates elsewhere also make US Treasuries incredibly attractive on a relative basis. 1.3% is a lot better than the 0.04% available on the Japanese equivalent, or even the 0.75% on the bonds of a country that was, not that long ago, seen as a big bankruptcy risk…Italy. And don't get me started comparing 1.3% with Germany's -0.32% 10-Year yield!!!
Obviously, Treasury yields can go lower, but will they? It may seem with all the talk of inflation that that is unlikely but, so far, the kind of intransigence that federal appointees are famous for suggests otherwise. Jay Powell has announced that inflation is "transitory" and therefore doesn't warrant rate hikes, and he has maintained that position, even as the evidence mounts that "transitory" in this case may mean lasting two or three years.
If the FOMC sticks to that view, then the weak jobs numbers for last month become the focus, even though a blip in unemployment is far more transitory than rising prices, and "normalization" of rates looks further away today than it did last week. Changing that dynamic would involve Jay Powell saying publicly that he was wrong, and admitting error is not something Fed Chairs tend to do much. So, if stocks drop, or even just wobble a bit, it will create a rush to bonds that could push rates significantly lower before the year is out.
If Treasury yields do continue their historic drop, then yields on other instruments: dividend stocks, MLPs, and REITs, for example, get more attractive. Their prices will go up and yield locked in now will look doubly attractive. That brings in investments such as the MLP ETF, AMLP, which offers a yield of around 8.3%, or the smaller, actively managed version of an MLP fund, AMZA. AMZA employs some leverage so is riskier, but it yields over 10%.
Both of those are worth a look, but the best value to be had for yield-seekers right now is in those European multinationals that cut their payouts so drastically last year. Dividends are discretionary payouts and can be raised just as much as they can be cut, and history suggests that RDS and BP will be looking to reinstate the cuts as things improve post-pandemic. Obviously, that opens up the potential for some big dividend increases over the next few months if oil and natural gas prices stay high, so the already decent income of around four and five percent that are available on those stocks can increase significantly on money invested now.
When you look at Treasury yields in isolation, logic tells you that they can't go much lower, but they don't exist in isolation, nor do they necessarily follow logic. They are traded internationally on a comparative basis and are dependent on the Fed's actions, and both of those factors suggest they can move lower before they go higher. That makes stocks withy high dividends, like RDS and BP, attractive anyway, but with the likelihood of dividend increase before long, they become even more so and move into the category of great trades.
Cheers,
M
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