Since the crisis hit, interest rates have been kept artificially to the lowest level the world has ever seen. This launched what was called the ‘hunt for yield’. As many investors ran for high-yield junk bonds, risk-averse investors who were uncomfortable with that level of risk turned to quality stocks, i.e. high dividend paying stocks. This particular class of equities has outperformed the market since the end of last year as players around the world were desperately searching for yield from any source they could find. Of course, one must admit that during a tumultuous financial environment, these stocks are also an insurance against disaster.
SDY – SPDR S&P Dividend (0.35%) – Blue | SPY – SPDR S&P 500 ETF Trust (0.09%) – Red
However, since ‘taper talk’ emerged from the FED in May of this year, the possibility of an increase in treasury rates was accompanied with an inversion of the quality stocks rally. They went into reverse gear, especially during the summer, as ‘taper talk’ intensified.
US Gov’t 10 Year Yield
However, Mr. Bernanke decided that September was not a particularly good month for the FED to end an 85 bn $ per month shopping spree of treasury bonds and mortgage-backed securities. We think that such a decision shall reverberate on the high dividend stock class, which is now facing a prolonged QE-program and thus a higher probability of low interest rates for longer than predicted. That is why we decided to go long on high dividend yield stocks (SDY – SPDR S&P Dividend) and short on the S&P 500, thus betting on a reduction in the spread you see above in the graph, with approximately a 1 month horizon.
Such a decision though, is highly affected by the impasse on the budget/debt ceiling issue going on in US. In case everything works out well by the 19th of October and yields manage to be suppressed, then the strategy should work fine as we might see a sanguine reaction of the high dividend stocks. However, just in case the US decides to do something crazy, like allowing the markets to witness a technical default by the first economy of the world, then the strategy might still yield some positive results given the short position in the S&P 500, whose beta of 1 is higher than the beta of the quality stocks.