- Inigo Fraser Jenkins, the co-head of portfolio strategy at Bernstein Research, spotted a trend in the market that hasn’t been seen in 65 years.
- With stock dividends yielding more than bonds, Fraser Jenkins thinks the “best fixed income portfolio” is comprised of large cap stocks with stable dividends.
- To arrive at his picks, dividend stability and history, balance sheet strength, and free cash flow yield were meticulously vetted.
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When the stock market trades on the loftier side of historical valuations — like it is doing today — investor affinity towards fixed-income allocations tends to increase. The thesis behind the move is simple: rotate from danger into safety.
But with US Treasuries yielding peanuts and a Federal Reserve that has vehemently expressed its disinclination to raise rates anytime soon, that dynamic has changed.
“US equities have reached their all-time peak multiple on forward earnings,” said Inigo Fraser Jenkins, the co-head of portfolio strategy at Bernstein Research. “Hence a focus on income could make sense.”
He continued: “However, the best ‘fixed income’ portfolio right now might actually be a portfolio of higher quality equities where there is some visibility on the dividends.”
To demonstrate his thinking, Fraser Jenkins provided the following chart depicting a widening gap between dividend yields and bond yields. The last time these levels were seen was 65 years ago.
“The spread of US dividend yields over bond yields is wider than at any point since 1955 which is the perhaps most obvious reason why the income trade may now be in equities,” he said.
Although relying on equity income is inherently riskier than bonds, to Fraser Jenkins, investors have limited options to choose from. What’s more, he says that bond investors have been taking equity-esque risk for years now as the reach for yield cajoles them into riskier securities. And with the threat of real negative returns, inflation, and high duration risk present within high-grade fixed income, the optimal portfolio may not include any bonds at all.
“Right now we think that the best fixed income portfolio is…. a portfolio of large cap equities where there is a good degree of confidence in the dividend,” he said. “Unsurprisingly this leads to stocks in Healthcare and Consumer Staples sectors, but also selected Commodity cyclicals, Industrial cyclicals and Utilities.”
To arrive at his picks, Fraser-Jenkins vetted free-cash-flow yield, dividend stability, and balance sheet strength. His 13 choices are listed in ascending order of dividend yield.
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