In last week’s article I mentioned that as a result of the renewed monetary policy easing measures by the world’s major central banks, almost a quarter of all debt issued by governments and companies around the world trade at a negative yield following the sharp rally in bond prices.
The eurozone bond yield ‘heatmap’ that was published last week clearly portrayed the negative yields across maturities of the various members within the eurozone as well as the remaining countries still offering a positive yield on their bonds. As an example, when taking the 10-year yield into consideration, the bonds issued by Spain, Malta, Portugal, Italy, Cyprus, Lithuania and Greece are the only ones giving a positive yield as the other countries all saw their 10-year bond yields move into negative territory.
The rally experienced by sovereign bond prices also resulted in the 30-year German bund dropping to a negative yield of -0.30 per cent towards the end of August.
Although there is a significant difference in interest rates between the US and the eurozone, the rally seen across sovereign bond markets was also evident in the US as the Federal Reserve changed course earlier this year by first adopting a ‘wait and see’ approach and then began to reduce interest rates following the series of hikes that took place between December 2015 and December 2018.
As a result of the rally across sovereign bonds around the world, towards the end of August when eurozone yields were at their fresh record lows, the yield on the 30-year US Treasury bond dropped to 1.96 per cent which was below the dividend yield of the S&P 500 of circa two per cent. This led some financial commentators to highlight that it was the first time that the dividend yield on the S&P 500 exceeded the yield on the 30-year bond since March 2009 which marked the lowest level for the equity market in the midst of the international financial crisis.
This does not necessarily imply that US Treasury yields cannot go any lower or that share prices should continue their sustained rally going forward due to the superior yield on equities when compared to sovereign bonds. In fact, as indicated above, the 30-year German bund dropped to a yield of -0.30 per cent (with the yield differential between German bunds and eurozone yields of circa 4 percentage points being much larger than that in the US). Moreover, there is increasing political pressure for the Federal Reserve to continue to reduce interest rates which would imply a sustained rally in bond prices and therefore a further reduction in yields. On the other hand, however, during last week’s Federal Reserve meeting, although interest rates were reduced by a further 25 basis points as was widely expected, the statement issued by the Fed indicated a level of caution of further interest rate cuts next year.
While the future trajectory of interest rates and the resultant level of bond yields is rather uncertain going forward across the eurozone and also in the US, the difference in yields offered by bonds and those from the equity market could be an eye-opener for several types of investors.
Although interest rate on bonds are fixed, price volatility can be rather intense as was evident in recent years
In Europe, for example, the dividend yields on some of the car manufacturers such as Daimler and BMW exceed five per cent mainly following the decline in the share prices in view of the weakening economic climate and political uncertainties such as Brexit and the US-China trade war. Meanwhile, the recent drone attacks on the Saudi oil facilities and the spike in the price of oil which naturally led to a rise in the share prices of the major oil producers, led some commentators to highlight once again the strong yields by several oil companies.
The Spanish company Repsol offers a dividend yield of 6.4 per cent, followed by the Italian oil company ENI at 5.8 per cent and the French company Total SA at 5.5 per cent. The oil price hike and the improved financial stability of these companies in recent years reinforced the belief that these companies can continue to sustain their dividend distributions also in future years.
UK Treasury yields are still in positive territory although these have also declined significantly in recent months. The 10-year UK Treasury yield is currently at 0.5 per cent and the 30-year yield is at just over 0.9 per cent. Meanwhile, the two major oil companies forming part of the FTSE 100, namely BP plc and Royal Dutch Shell plc, both have dividend yields of above six per cent. Similarly, Vodafone Group plc is trading on a yield of five per cent while much higher yields of between nine per cent and 11 per cent are available from some of the housebuilders.
The situation in Malta is similar to that in other regions with the dividend yields on most shares superior to the yields available from Malta Government Stocks. The 10-year MGS currently gives a yield to maturity of only 0.16 per cent. Few may recall that the yield on a 10-year MGS was 2.7 per cent in mid-2014 which shows the sheer decline in yields in only five years following the QE programme by the ECB as from early 2015. Meanwhile the longest dated Maltese sovereign bond with 22 years until redemption, the 2.4 per cent MGS 2041, currently gives a yield of only 0.75 per cent per annum. The rally seen across sovereign bonds internationally was also evident in Malta with the price of the 2.4 per cent MGS 2041 jumping by an extraordinary 26 percentage points since the start of 2019 resulting in a corresponding decline in the yield from two per cent at the end of 2018 to the current level of 0.75 per cent.
Meanwhile, several equities in Malta are trading on historic net dividend yields (based on the dividends distributed in respect of the 2018 financial year) in the region of three per cent namely GO plc, Maltapost plc, Plaza Centres plc, Tigné Mall plc, Malita Investments plc and Main Street Complex plc. When excluding any special dividends and basing one’s calculations on the dividends distributed in respect of the 2018 financial year, the highest dividend yielding equity is Mapfre Middlesea plc at 4.5 per cent. Meanwhile, the most recent company to list on the Regulated Main Market at the start of 2019, BMIT Technologies plc, had stated that its dividend policy entails the distribution of a maximum of 90 per cent of free cash flow but not exceeding 95 per cent of distributable profits. Based on the financial projections for the current financial year to December 31, the dividend is projected to amount to €0.0216 per share, representing a net dividend yield of 4.08 per cent based on the current share price of €0.53 per share.
Although investors may have been increasing their exposure to the equity market to improve their investment income and this may intensify in view of the renewed downturn in bond yields, it is important for such investors to be aware that dividends are not fixed from one year to the next similar to the coupons on sovereign and corporate bonds. Dividends may fluctuate or can be cancelled from one year to the next depending on individual company circumstances such as cash flow requirements, capital expenditure plans, regulation, etc. Many Maltese investors should now be aware of this following the lack of any dividend from Bank of Valletta plc since the 2018 financial year.
As such, investors need to select those companies which can sustain their dividend also in future years by assessing their overall risk profile, the level of indebtedness of the company and also the overall strategic direction being taken. On the other hand, it is also worth highlighting that although interest rate on bonds are fixed, price volatility can be rather intense as was evident in recent years.
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