UBS | German 10yr bond yields have turned negative and some European corporates are effectively “being paid to borrow”. What are the implications for European equities? Although there has been a deepening of Global growth fears in recent weeks, economic surprise indicators and PMIs have not collapsed. Instead, risk aversion has risen sharply given event risk in June and in particular, the UK referendum. Bullish sentiment (US AAII) hit a 20 year low in the last few weeks (Figure 1) and our Macro team’s Global Indicator of Risk Aversion is at extreme levels.
Gap between European Credit yields and Equity yields at extreme levels…
Lower sovereign bond yields have driven the gap between equity and credit yields to new extremes. Credit spreads have widened somewhat, but this has not offset the fall in sovereign bond yields: in the last three weeks Eurozone corporate credit yields have fallen from 1.37% to 1.21% and at the same time the equity dividend yield has risen from 3.4% to 3.7% (Figure 2).
Where are the dividends and will they get paid?
We run a Heatmap looking at where the yield is by sector and by country: Energy, Financials and Utilities have the highest yields. Mapping the dividend yield against the pay -out ratio helps indicate potential stress in dividends.
Where is the yield? The 2016E dividend yield for the Pan- European Market (Stoxx 600) is 4.0%. Over a third of the companies in the index have a dividend yield over 4% and just fewer than 15% of the companies have a yield over 6%.
But this is split by a number of ways. We draw up a Heatmap to drill down at a country and sector level for where the yield is. Three sectors stand out: Financials, Energy and Utilities. Telcos is somewhat more mixed, given lower yields in Italy.
Energy appears the most extended on this measure, but we would highlight cash earnings have fallen far less than EPS, suggesting dividends may be under less pressure than first appears.
Cyclicals vs Defensives close to 15yr lows…
The change in Bond yields has been a driver for the relative performance of Cyclicals vs Defensives. This is now back below the March 2009 levels (even ex -Banks). Despite the bounce since mid-February on sector rotation, when observed from a long -term perspective, even this has hardly moved the needle.