GARY Top 10: Yield investing outperforms in a slowing global economy

Macro Cycles

The unwinding of the Japanese carry trade has sounded an alarm, and it’s likely to worsen with US Fed rate cuts and BOJ hikes. This week’s Japanese inflation update will add to market uncertainty. The US recession outlook remains unstable, even as underlying data continues to decline. Markets persist in assuming that rate cuts will lead to a soft landing, despite the US Fed's lack of success after inflation surpasses 5%. Although a lagging indicator, US and local job markets are beginning to unravel as unemployment rates continue to climb.

Policy Outlook

The market anticipates 100bps cuts from the US Fed in 2024 to justify the relief bounce, while the US Fed has signaled much lower cuts. Weakening employment data indicates a slowing US economy, with high asset prices adding inflationary pressure. If the Fed cuts align with market expectations, we expect investors may panic over recession fears. The US election has become an even contest, but neither party has outlined plans to curb debt, address geopolitics, or achieve a surplus. RBA is expected to remain on hold in the short term.

Data Analytics and AI takeaway

The major growth/value trend still favors value in the local market, while the global shift toward value paused after last week's relief bounce driven by US mega techs. Investment factor trends reveal that momentum, size, and volatility outperformed last week, while profitability, dividends, and value led over the past month. Despite media narratives, data indicates that small-cap and micro-cap stocks remain high-risk, even with the recent pullbacks after the inflation/interest rate cycles.

Investment Strategy

Yield investing, the strategy of focusing on income-producing assets, becomes increasingly complex in an environment characterized by high interest rates, slowing economic growth, and elevated market risks. Traditionally, high-interest rates would benefit fixed-income investors by providing more attractive yields on bonds and other interest-bearing assets. However, the current economic landscape, marked by slowing growth and the anticipation of rate cuts, presents a challenging dynamic for yield investors. The GARY (Growth At Reasonable Yield) model from Deep Data Analytics offers that mix of outperformance and risk management.

In such a scenario, the expectation of future rate cuts suggests that the current high yields may be temporary. Investors need to carefully assess the duration and credit quality of their investments. Long-duration bonds, for example, could see price appreciation if rates begin to fall, but they also carry significant risk if economic conditions deteriorate further, leading to increased default rates or further economic slowdown. Additionally, high-interest rates tend to pressure corporate earnings and consumer spending, potentially leading to increased market volatility and heightened credit risk.

Given these risks, yield investors might consider diversifying their portfolios to include assets that offer a balance between income generation and capital preservation. This could involve a mix of short-duration bonds, which are less sensitive to interest rate changes, and high-quality dividend-paying stocks, which may provide some level of income stability even as market risks rise. Furthermore, investors should remain vigilant in monitoring macroeconomic indicators and central bank signals, as the timing and magnitude of potential rate cuts could significantly impact their yield strategies.

In summary, while yield investing remains a viable strategy, the current environment demands a more cautious and adaptive approach. Balancing the pursuit of income with the need for risk management and flexibility will be key to navigating the challenges posed by high interest rates, slowing growth, and an uncertain future. Deep Data Analytics’ Growth At Reasonable Yield (GARY) strategy offers that with consistent premium outperformance over the long term.

Model Portfolio

Growth at Reasonable Yield (GARY) Top 10 does not include any major banks, big miners or major property trusts. The stretched asset valuation, weak local economic outlook and weak China fundamentals suggest that these major sectors of the local market are being mainly held up by global passive funds while the earnings are facing cyclical decline. We don’t see the overall market multiple as sustainable while some segments of the market offer substantial outperformance. Hence the data driven targeted sector/stock selection strategy continues to outperform in volatile outlook.

The best performers over the last three months in the Growth at Reasonable Yield (GARY) Top 10 are: Codan (ASX: CDA), Elders (ASX: ELD), Evolution (ASX: EVN), Sonic Healthcare (ASX:SHL) and Telstra (ASX:TLS).

Note: DDA may or may not have made changes to the model holdings since last update. The data driven model portfolios will continue to evolve with the economic and market cycles.